The Government recently unveiled plans to ban the sale of new-build leasehold homes under proposals to prevent homeowners paying unfair fees.
Derek Ching, partner in the development and housebuilding team at law firm Boyes Turner, looks at how existing leaseholders have been left out in the cold.
Escalating ground rents associated with recently built leasehold residential properties have been generating growing controversy. The government rushed out a consultation paper as the summer holidays got underway, setting out plans to outlaw rapidly increasing ground rents within leases. Nationwide Building Society was first to withdraw lending for properties where the leases contain such provisions, and others followed. Inevitably the bulk of lenders will fall into line.
However, government plans only extend to future new builds. This leaves open the question of what happens to the owners of existing leasehold properties with such terms – particularly if more mortgage providers refuse to lend against them. The unintended consequences could be severe. The market for properties subject to these leasehold terms could start to dry up – leading to a collapse in the value of such properties. Remortgaging may become difficult or impossible – with rising LTVs bringing higher interest rates or, in extreme cases, refusal of credit.
One solution is to agree to get the landlord to agree to vary the lease. Even if a landlord demands no payment for the variation, there will inevitably be legal costs incurred as well as Land Registry fees. Lenders will also have to give their consent to the change incurring more fees. Variations involve a piecemeal process and could give rise to different properties on an estate being valued differently depending on whether the ground rent clauses have been updated.
Developers may be willing to enter into bulk variations of leases in their developments. Nevertheless even with a bulk approach, the complexities of obtaining lender consent remain.
Overall, though, mortgage lenders find themselves in a delicate position. The issue of exorbitant ground rents is already starting to affect property values. In extreme cases this could give rise to negative equity.
Individual cases won’t have a significant adverse impact on a lender. However, taken across the whole of a residential mortgage portfolio, the cumulative effect of downgrades in value of their security could start to have an impact on their business generally. The adverse impact of this controversy will not be as great as the “sub-prime” mortgage scandal, but reduction in the quality of the assets contained within a security portfolio could nevertheless cause discomfort and perhaps regulatory concern.
Another problem – highlighting the complexity of the issue – is that some lenders will also be exposed to risks from their property investor customers. In many cases, portfolios of ground rents have been sold on the commercial market to private and institutional investors. These assets have been valued by reference to the anticipated income streams derived from the original ground rents and predicted rises in income using the escalation clauses in the leases. Any variations will inevitably reduce the values of those portfolios.
The Government consultation paper makes no proposals to tackle controversial ground rent provisions contained in existing leases, merely inviting suggestions for future solutions. Given the substantial consequences of legislation applying to existing leases, this is perhaps unsurprising.
A general restriction on the levels of ground rents would only work if it applied retrospectively. Tearing up contractual obligations entered into between landlords and tenants would be a nuclear legislative approach and seems unlikely to be pursued. It would be, in effect, compulsory purchase of the right to receive ground rent income above a certain level – bringing certain legal challenge.
Arguably, the market is already resolving the ‘easier’ problem the government is planning to legislate for. But the thousands of homeowners already subject to potentially punitive ground rent provisions will face costs making changes to their leases to facilitate future sale or re-mortgage. If they do not, they could find that they will suffer through reduced values, abortive sales or more expensive mortgages.
Because of the complexities and cost of making changes to long leases, there may be some attraction for residents on an estate or within particular blocks of flats to band together to make a joint approach to their landlords. In this way there may be some savings in costs due to the economies of scale.
However, this may not be a simple circle to square. Investors in ground rents will be reluctant to concede reductions in their income without compensation. Payments to unpick existing lease terms seem inevitable. The amount would depend upon how extreme the ground rent clauses are in any particular lease.
Some developers will voluntarily enter into agreements. Some will offer variations only to the original buyers. Others may go further in order to protect their reputations and agree variations on all their affected leases, even those where subsequent sales have taken place. Whether developers will fund the cost of variations on sites where they have already sold the ground rent rights is another question.
The problems facing the mortgage lenders are similarly complex. Nationwide Building Society led the way by stipulating the criteria which they would recognise as being “acceptable” for ground rents. Others are following. The lending industry is yet to adopt a standard approach. At the time of writing, the Council for Mortgage Lenders (CML) Handbook – the bible for conveyancers for what is or is not acceptable in relation to property mortgages – offers only generic advice, although some lenders have specified their own requirements. CML say they are looking at this which should provide an industry-wide standardised approach for new leases and hopefully also for existing leases on “non-compliant” terms.
The lending industry can also help by adopting streamlined internal procedures for leaseholders to secure their formal consent as lenders to changes to ground rent structures. This will help reduce cost and delay.
It is to be hoped that lenders will adopt a sympathetic approach to cases where unwitting homeowners have signed up to onerous ground rents when it comes to re-mortgaging or allowing conversion of mortgage products when fixed rate deals expire. Buy-to-Let investors may however be seen as less deserving as they are running a business and so be expected to have understood what they were signing up to. The government’s action on future properties was bold, but this story has a long way to run.
Derek Ching is partner in the development and housebuilding team at law firm Boyes Turner
