This is a topic which has received a huge amount of attention over the last 12 months, culminating in the government's consultation paper on leasehold reform launched in July 2017. Reports of block notifications abound, across the property professional sector, but are these likely to produce large scale exposures for professionals and their PI insurers?
The issue
Historically ground rents in long leasehold titles were fixed at extremely modest levels, often ranging anywhere between simple peppercorn (£1) and £50 per annum and these, due to the low values, were often not even collected by freeholders.
In the last decade, however, new types of ground rent clause began to appear in long leasehold titles of new build residential properties. Not only were higher starting figures introduced, often between £250 and £500 per annum, but also these became the subject of review every 10 or 25 years.
Many of these clauses simply doubled the ground rent on each review; giving rise to egregious growth during the overall term of the lease; frequently between 125 and 999 years. Take a fairly common example for illustrative purposes; a £250,000 house purchase with an initial ground rent of £500 per annum and a 'doubling' review cycle every 10 years over the 125 year term.
What appears to be a relatively modest ground rent liability at the outset will soon morph into a significant liability; annual ground rent liability by the 50th anniversary will have risen to £16,000 and by the 100th anniversary an eye watering £512,000.
The realisation
Why has this become an issue now, against the initial appearance that it will take a number of years before the ground rents begin to spiral? Pursuant to the leasehold reform legislation the right to acquire the freehold interest and/or seek to extend the term of the original lease arises after a period of 2 years ownership.
This is a right that was frequently used as a selling point to those contemplating leasehold purchase, particularly where houses (as opposed to flats and apartments) were involved. Social media and press reports frequently talk about house purchasers being told they could acquire the freehold for a relative modest cost of around £3,000 to £4,000 after the 2 year qualifying period.
Once this qualifying period ends, homeowners who looked to exercise the right discovered that the cost could be very different to that suggested at the time of purchase. Media reports started to surface with anecdotal stories of homeowners being quoted figures of anywhere between £25,000 and £75,000, a far cry from the pre-purchase indications.
Why? Although the basis of assessment under the legislation is far from simple, the process considers the investment value of the right to receive ground rent over the term. Suffice to say, rapid ground rent growth significantly increases that investment value whilst diminishing the leasehold value in equal measure.
The consequences
As news of this problem spread, the lending industry became extremely cautious about accepting leasehold titles of this type as security, in light of the obvious dangers posed to a property's value over the term of the mortgage. This, in turn, caused numbers of 'subject to contract' sales to fail, leaving many with properties that were unsaleable.
By May 2017, Nationwide Building Society changed its policy to deem all leasehold title unacceptable unless the ground rent throughout the term of the lease was reasonable, as a maximum not exceeding 0.1% of the property's value. Many other lenders seem to have followed Nationwide's lead.
A further complication is a rather unintended one. The Housing Act 1988 deems long leases over 21 years where annual ground rents exceed £1k in London and £250 elsewhere, i.e. a very large number of instances indeed, to be assured tenancies. As currently provided for in the Act, arrears of rent (including ground rent) provide a mandatory ground for possession.
Political reaction
On 21 July 2017 the Government issued a Consultation Paper entitled "tackling unfair practices in the leasehold market". The 8 week period for stakeholder response has closed and the results are currently being considered.
The paper noted that there were 4 million leasehold properties in England in 2014-15 and, of these, 1.2 million were leasehold houses. In 2016, around 10,000 new build leasehold houses were sold, out of around 57,000 sales of leasehold houses in England
Serious consideration is likely to be given to outlawing the creation of new build leasehold houses and limiting the level of starting ground rents and future escalations on all new residential leases. If this happens it will close the door on future problems but will not help all those homeowners who currently find themselves with rapidly escalating ground rent clauses.
Even the Government seem to accept that retrospective action will be difficult; although one question in the consultation papers did invite responses to "How could the Government support existing leaseholders with onerous ground rents?". In reality an industry solution appears more likely but even this will not be without potential difficulty.
This is because the management of freehold reversionary interests is not seen as a core part of a house builders' business, such that these are typically sold to third party investors who specialise in releasing the value in the ground rents. In light of the escalating ground rents and impact that has on the value of the freehold reversion, this has become big business. One source, the Secretariat of the All Party Parliamentary Group for leasehold reform, estimated in late 2016 that UK house builders were generating between £300-£500 million a year from these sales.
Industry response
The consultation paper did praise one major house builder for creating a fund to support its customers, noting that "parts of the industry are taking action to support leaseholders with onerous extant ground rents. In April 2017 Taylor Wimpey announced it would set aside £130 million for a Ground Rent Review Assistance Scheme for its customers facing doubling ground rent terms. We welcome this, and are keen for others to follow suit".
Media reports suggest that this scheme, whilst most welcome, is limited to those customers who remain the owners, i.e. bought a new build property and have not since sold it on. It is envisaged that these people will be compensated through the voluntary scheme and it is understood that most third party freeholder reversion investors have been brought on board and will permit rectification. It does not, however, appear to assist those who have bought 'second hand'.
In August 2017, another major house builder announced that it would buy back a large number of freehold reversions from one third party investor so that it could then rectify the ground rent provisions so as to limit future escalation to reasonable levels, likely to be RPI/inflation linked. Similar steps have been announced by at least one third party investor. What the other major players decide to do remains to be seen.
Professional targets
Unsurprisingly, claims firms have started to advertise heavily in the media looking to sign up home owners who own property on leases which are the subject of escalating ground rent clauses. The clear aim is to look to bring claims against the professionals who advised them at the time of purchase. It is also possible, in any case of mortgage default, that lenders will seek to claim if the realisation of their security is affected by the nature of the ground rent clause in the lease.
Solicitors will inevitably be first in the firing line but lawyers are not themselves valuers. Whilst a failure to mention a rapidly escalating ground rent clause will be a difficult position to defend, mere mention of its terms without advice as to its potential implications (from both a leasehold reform perspective and a future security/investment standpoint) is an altogether different matter.
What about Mortgage valuation and Homebuyer surveyors? It is often the case that the lease itself is not made available to the surveyor and reports will prudently reference that fact and say, aside from reference to the term of years left to run, that "it is assumed it contains no onerous conditions".
There is little doubt that a ground rent clause which doubles every 10, 15 or even 20 years may well be regarded as 'onerous' but the altogether different question is whether the surveying profession will be able to seek refuge behind the assumption. Much is likely to turn on the awareness of those actively engaged in the valuation of new and recently new properties to the fairly widespread use by house builders of escalating ground rent clauses over the last decade or so.
Estate Agents also need to be alive to the issue and to ensure that, wherever dealing with the marketing of an estate house built since the new millennium, the ground rent clause is checked to determine whether or not it is reasonable or not. The Consumer Protection from Unfair Trading Regulations 2008, which replaced the Property Misdescriptions Act, outlaws not only misleading and untruthful statements but, more significantly, what are termed 'material omissions', i.e. omitting to mention a known negative which would likely influence a purchaser's decision making process.
Limitation may, of course, be a factor and will need to be borne in mind in all cases where the lease purchase occurred more than six years ago although the latent damage provisions may be deployed to resist any argument that a claim is time barred, dependent of course on the circumstances.
What next?
Only time will tell whether what is perceived by many to be a housing scandal will prove to be a major headache for property professionals and their PI insurers. Claims seem inevitable and clear strategies for dealing with them which reflect what is likely to be a fast moving landscape going forward are essential.
Clearly the first port of call ought to be an invitation to the freeholder to rectify the clause to one which is acceptable to both homeowner and lender (if any) alike. After that only time will tell what the government is, whether through legislation or industry liaison, able to achieve from a retrospective standpoint.
What is clear is that those who have already had to abort sales can be expected to bring consequential loss claims which, if a decision was taken to sell at a discount, could result in losses in excess of simple wasted costs.
Ultimately the real 'cost' could prove to be the time spent administering large numbers of notifications and potential claims which, individually, are of limited real value. But, of course, a very different picture could emerge if the industry resists government pressure and fails to follow the lead set by the few to date.
