One of the most important factors in property purchase relates to whether you are purchasing the property and the land (Freehold) or simply the part or the whole of the property and leasing the land (Leasehold)?
Do you understand the differences and the implications?
Freehold ownership means that the land is owned as well as the property on the land… FACT
Leasehold means the land is not owned, and the owner buys the right to use the land and usually part of property for a period of time, usually over 100 years when the lease is first granted. As each year goes by, the lease becomes shorter until the land and property reverts to the landlord.
Within a leasehold arrangement, ground rents are payments awarded to the freeholder of a property, which are not to be confused with service charge payments that are used to maintain the property. For the leaseholder, these payments are a fraction of their lease value but failure to pay results in the leaseholder losing their property to freeholder. Consequently, default rates have historically been very low.
Ground rents are an unusual breed of financial instrument as their value is far lower than the asset serving as collateral, thus creating a rare occasion where a default event is potentially the best-case scenario for the freeholder. They have in more recent times become a business all of their own.
For a leaseholder faced with the option of paying, for example, an annual ground rent of £200 or losing their property worth perhaps £200,000 the choice is simple and this is why the payments tend to be so reliable.
For many freeholders, administering the collection of these ’token’ payments are regarded as an inconvenience or a non-core business activity, so they choose to sell their ground rent claim.
Institutional and other investors have been accumulating portfolios of ground rents for many years and specialise in the administrative process of rent collection that has served to deter many investors from participating.
The payment value of a ground rent is set at the point of leasehold sale and includes terms for periodic increases, such as doubling every 10 years or increasing every five years in line with Retail Price Index.
In an environment of record low interest rates, the demand for alternative sources of defensive, inflation-protected cash flows has soared. Ground rents have been a beneficiary of this and over recent years’ investor demand has driven up prices so capital appreciation has far exceeded the actual ground rent payment. .
Service charges are one of the principal areas for dispute between leaseholders and their landlords.:
Service charges are levied by landlords to recover the costs they incur in providing services to a building. The way in which the service charge is organised is set out in the tenant's lease or tenancy agreement. The charge normally covers the cost of such matters as general maintenance and repairs, insurance of the building and, where the services are provided, central heating, lifts, porters, lighting and cleaning of common areas etc. The charges may also include the costs of management by the landlord or by a professional managing agent and for contributions to a reserve fund.
Originally, the costs of services were included in rental payments, but as costs and inflation escalated, landlords wanted to make sure they recovered all their costs every year. Some old leases still provide for a fixed charge to be levied, regardless of the actual costs to the landlord. However, most service charges are based on the actual or estimated cost of the services and thus vary from year to year. These are known as variable service charges.
Generally, the landlord is under an obligation under the lease to provide certain services, and in return has the ability to levy a service charge for doing so. The lease will dictate the format of the charge. It will usually give the dates of the service charge period and how often payments are to be made. More often than not the service charge period is a year, but payments may be required on a half-yearly or a quarter-yearly basis, or in some cases in arrears.
The lease will usually set out the percentage or proportion of the service charge payable by the lessee. For example, it may require the leaseholder to pay a proportion of the charge based on square footage of the flat as a proportion of the whole building; Sometimes the lease just stipulates a 'fair' or 'just' proportion. If different groups of occupiers benefit from different services, there may be provision for more than one percentage or proportion to be paid.
The lease will say whether advance payments are to be made and, if so, whether they are based on the previous year's cost or an estimate of the cost in the year to come, for example. There will often be provision for a final charge at the year end when the actual costs are known and exceed any interim payments. In this situation a demand will be sent out for the shortfall. If interim payments have been made, and they exceed expenditure, the lease may provide for a credit to the leaseholder for next year's charge, occasionally a refund, and sometimes a provision that the excess is put into a reserve fund.
Service charges can go up or down without any limit, but the landlord can only recover those costs which are reasonable. Leaseholders have rights to challenge service charges that they feel are unreasonable at the Tribunal. When considering the purchase of a leasehold flat, it is important to find out, for personal budgetary purposes, what the current and future service charges are likely to be.
Would you like to know more? Contact us to understand:
- What is a sinking or a reserve fund?
- What powers does the landlord have to recover service fees?