In Defence of Leasehold 4 Comments

In Defence of Leasehold

Forward

Much of the bad press leasehold has had of late results from the cladding crisis triggered by the appalling disaster of Grenfell Tower. I have nothing but sympathy for those tenants of flats caught in the impossible position of having either to pay unaffordable sums of money for repair or find themselves unable to sell their flats; maybe both. That is beyond question shockingly unfair and I in no way condone it. It is beyond the scope of this post to apportion blame or to suggest solutions; hopefully the Grenfell enquiry will go some way towards doing that. I will propose, however, that, contrary to the apparent belief of some campaigners, the leasehold system is not the culprit.

Consequently, much of what follows relates to leasehold residences which form part only of a building, and I will use the word flats to include maisonettes and any other units which in the US would be called apartments (whether penthouses, duplex, triplex or other). I will only briefly mention houses, and the value of leasehold in the structuring of ownership of commercial property.

Finally, most of my posts to date have been designed to be read, though not exclusively, by lawyers. The subject of this post will I hope be of interest to a wider readership.  I have, for that reason, sought, as far as possible, to eschew legal terminology.  The probable result is that lawyers will find my language imprecise, and lay readers will dismiss my arguments as technical. Compromise famously pleases nobody, but I will do my best.

Leasehold ownership of residential houses and flats has been getting a very bad press lately. Are all the criticisms justified? I suggest not. I will say why and then re-examine the issue in the light of the government’s latest proposals for lease extension and enfranchisement.

Many of the detailed criticisms appearing in the press have been based on misconceptions. For example:

1)      Crusading journalists are fond of describing the leasehold system as “feudal”.  That is incorrect. Leases as interests in land were not recognised under the feudal system. Leaseholds became “estates in land” only around the end of the 15th Century. The only interests in land recognised in feudal times were, somewhat ironically, freeholds.

2)      In commenting on the cladding scandal, campaigners are also apt to say that “the leasehold system” requires tenants to pay for the expensive repairs necessary to make the building safe. If by “the leasehold system” these journalists mean “leasehold law”, then their allegation is simply untrue. Where tenants are liable, it is not because of the leasehold system, but because of the terms of individual leases; and, though I will no doubt be criticised for saying it, conveyancers advising buyers of leasehold flats should all along (before and after Grenfell) have been advising their clients as to their potential liability under “service charge” clauses which enable the landlord to recover far more than the cost of what is normally understood as repair. Every time I read of a leaseholder being unaware of the potential impact of their liabilities for service charges and ground rents, I wonder who advised them on their purchase.

3)      Some writers go further and say, or imply, that service charges payable under flat leases are inherently unfair. They are not. These commentators seem to fail to understand the two reasons why flats are normally leasehold (although it has always been possible in theory to create a freehold interest in a flat); first, flats are parts of a building only and it is simply not practicable to give the owner of a part of a building the right to do as they like with it, to the potential detriment of the building’s structure and common parts and the amenity of other occupiers; and secondly, someone must pay the ongoing costs of the repair, maintenance and management of the exterior, structure and common parts, and who else should that be but the leasehold flat owners, just as the freehold owner of a house must pay for its repair?

4)      It is also being said that leaseholders are not “owners” of their property, and that the only “owners” are the freeholders. Again, that is simply not correct. Yes, a lease is a contract, but it is far more than a licence to occupy; it also creates an estate in land. Where property is subject to a lease, both the freeholder and the lessee are owners in the full sense of the word.

I can already hear critics sweeping aside what I’ve said so far as “mere technicalities”. I think they are more than that. If you put all of these criticisms together, they enable leasehold to be convincingly portrayed as a historic anomaly which is way past it’s sell-by date, systemically unfair, and fundamentally rotten, when in reality it is none of those things.

Leasehold,Vs,Freehold,Is,Shown,On,The,Business,Photo,UsingSo, what is really wrong with leaseholds? What makes leasehold interests inferior to freehold? In my view, not much. Historically, the distinction has been between a form of personal property (in legal terms, a chattel interest) as opposed to a “real” estate, i.e., freehold. For all purposes relevant to this post, that is no longer the case. I have so far avoided quoting any statutes, cases or learned works, but an extract from a leading textbook on property law illustrates my point here in a very accessible way:

“Nevertheless, their [leaseholds] inferiority exists only in history and in theory. A rent-free lease for 3000 years may be as secure and as valuable as any freehold estate”.

Whilst that is true, leaseholds have always been treated as of less value than freeholds, and the limited duration of a leasehold is only the first of the three main reasons for that. The other reasons are in my view more important; leases over the course of this and the last century have become more and more restrictive and controlling in their terms; and, of course, a lessee must pay ground rent.

I pointed out above that, in the case of flats, there must necessarily be restrictions, as the owner of a slice, or partial slice, of a building cannot be free to do anything they wish with it. To take an extreme example, a flat owner cannot be permitted to remove parts of his property which would imperil the building of which the flat forms part. Other restrictions relate to the need for good management and the avoidance of nuisance, e.g., restrictions against alterations, change of use, and nuisance. The commonhold system now favoured over leasehold by the Law Commission and, it appears, the government, does not make these restrictions any less necessary, as we shall see.

So far as ground rents are concerned, in the late 19th and early 20th centuries, ground rents tended to be nominal in amount and fixed for the entire term.  It is, sadly, true that in the latter half of the 20th century, and the past 20 years of the 21st, landlord developers have increasingly included in leases provisions for the periodical review of the ground rent; I have seen clauses which double the ground rent periodically (often every 20 or 30 years), and others which tie the ground rent to the Retail Price Index (or some other index).  Clauses such as these can make a flat unmortgageable and, therefore, unsaleable and, it seems are now to be banned, at least for the future (we await the small print as to existing leases).

View,Of,A,High,Rise,Tower,Block,Apartment,Building

So, we must now ask in what ways the commonhold system now to be promoted is superior to the leasehold system? A commonhold interest is a freehold interest, but does that in itself make it better? The answer, I believe, is in one way only; and that is the duration of the interest. At this stage, we need to take account of the other recommendations which have now been accepted by the government. Again, we await the small print, but essentially the proposals will allow leaseholders to extend their leases for 990 years with no ground rent payable. That is well over ten lifetimes, especially when the unexpired term of the existing lease is added. I have already pointed out that, in terms of restrictions and control, commonhold is no improvement on leasehold. In a commonhold scheme, no doubt the individual units will include the interior only and the structure of the building will form part of the common parts (along with external areas, entrances, lifts, corridors etc). There will be restrictions similar to those in a properly drafted lease.  The Commonhold Community statement replaces the lease and the Commonwealth Association replaces the landlord, and their respective roles are not much different. Furthermore, and this is very important given the cladding crisis being one of the main reasons for current concern over leaseholds, each unit owner will have to contribute to the cost of repairing and maintaining the common parts; and this would include the cost of replacing unsafe cladding.

In fact, in one sense, the commonhold flat owner may be in a worse position; in the case of a commonhold, there is no other party who might be held liable for the cost of, major repairs, including replacing defective cladding. There is no doubt at all that it is the commonhold flat owners who must pay. At least in the case of a lease, there is the possibility of the freeholder landlord being liable for the cost. I have noted that modern long leases of residential flats have extended “service charge” provisions under which the landlord can recover this kind of expenditure, but that has by no means always been the case. I wrote about this in my earlier post, and although I was corrected in relation to the bulk of the leases granted in the last 20 or 30 years, I have checked my own records and have found several leases granted between 1960 and 1990 which enable the cost of routine repair only to be recovered (that does not, of course, mean that the landlord will pay – it may just lead to a deadlock and the tenants as the most interested parties might find themselves having to pay the cost anyway, but at least there are two candidates and the possibility of negotiation).

I think there is one other respect in which commonhold might not be an improvement. Something that is being claimed to be one of the great advantages of commonhold over leasehold is that decisions in relation to the management of the building concerned will be made collectively by the flat owners rather than by a third-party landlord. In my experience, that is not always an advantage. I have been involved with more than one “tenants’ management company” in leasehold blocks and observed a drop in management standards due to the inexperience and differing interests of the directors and owners. To take an obvious example, those tenants who are well off may prefer a higher standard of repair than those who are less well off. This is very much a personal view but it is based on my own experience and on the experience of other people who I have spoken to and who have been involved with similar companies. There is a lot to be said for management to a high standard by professionals appointed by an independent landlord – not all landlords are greedy and exploitative. Of course, the commonhold association may, and almost certainly will, appoint professional managing agents to deal with the day-to-day management but any such agents will only act on the instructions of their clients, who may well disagree among themselves, causing delay in important decisions and, occasionally, references to the First-tier Tribunal.

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The comments made above apply mostly to flats rather than houses. I agree with those who say that houses should in the main be sold as freeholds. I do, however, think that there are major exceptions to that. An extensive estate with common external gardens, roads, footpaths and other external features may well be better served by a leasehold structure, for all the reasons given above in relation to the management of blocks of flats. This would be particularly so in the case of something like a model village with common facilities. It would in my view be wrong for the government to seek to bar enlightened developers from developing this kind of property and ensuring continued maintenance of its features by granting long leases, rather than freeholds.  Without leasehold, would we have the beautiful Nash terraces of Regents Park?  Or many of the other developments of the Georgian and Victorian eras by the great London Estates, who ensured continued quality and consistency through the leasehold system at a time long before the introduction of Town and Country Planning?  Probably not, and what a loss that would be.

In essence, therefore, I do not see the justification for seeking to replace a system which is well understood by the property industry and property professionals (and, I would suggest, by most people) with a system which is unfamiliar, no better, and just as, if not more, complex, creating unnecessary administrative burdens for all involved in the property industry, including, I would guess, the Land Registry.

In looking at the government’s proposals, I have not referred above to the proposals to lower the cost of leasehold extension and enfranchisement. I mention it here only because although, as I have said, we are yet to see the small print, the proposals as currently framed do appear to be very confiscatory for landlords. I am not sure what is going to be proposed regarding existing ground rent review mechanisms deemed to be unfair. One thing which is clearly proposed is the “abolition” of marriage value in the calculation of enfranchisement or extension prices. This does seem unfair. Marriage value is not just hypothetical – it is a fact that an enfranchised flat or house will be worth more than the combined value of the previous leasehold and freehold interests. On the basis of the proposal, this would amount to a windfall for tenants at the cost of landlords. I doubt that this proposal is going to get through without challenge. Those readers who have been around for long enough may remember the Duke of Westminster’s challenge before the European Court of Justice in relation to the Leasehold Reform Act 1967. I am not sure that it was one of the Court’s grounds for upholding the legislation, but it was a fact that the 1967 Act provided for what most people regarded as fair compensation for the landlord. It seems that will no longer be the case, and I can’t help wondering what the Supreme Court would make of a challenge by judicial review.  I can’t think of any other legislation which enables one private citizen to, in effect, confiscate the property of another. If readers can I’d be glad to hear from them.

Finally, I said in the Foreword that I would briefly mention leasehold and commercial property.  It may not be necessary, as I don’t think the government is planning to abolish leasehold entirely, but in my defence of leasehold it is relevant to say how essential its flexibility has proved in structuring the ownership of commercial property.  One important example is the equity sharing or “side by side” lease, which enables a charitable or other institution to procure the development of its property by granting a long building lease with a ground rent equal to a share of the market rents paid to the developer for space in the developed building. In this way the institution can procure development, retain an interest, and share in growth.  Another example where leases can help is where a development site has multiple owners. In one case in which I was and am still involved a leasehold structure was used to ensure the preservation of an important part of London whilst preserving its commercial value (details on request).  Apologies if this paragraph contravenes my promise to avoid technicality; it is directed mostly at lawyers.

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This Post Has 4 Comments

  1. Duncan Crook says:

    A very interesting post. I particularly agree with your comment about solicitors, although extend to other professional advisors. I’m unsure of the extent of responsibility in law, but to my mind the role of an expert advisor (solicitor and/or IFA) must include an assessment of risk for their client, similarly the mortgagee should have a duty of care to their client.

    A (perhaps extreme) analogy: restrictive covenant banning occupation would surely give rise to a right of redress if missed by a professional advisor, although Joe Public challenging a professional advisor is by no means a trivial task. Another might be unpaid S106, should the S106 agreement not protect a future occupier against liability.

    Similarly, SME developers rely on advice when forming the leasehold interest, therefore it is possible that some unfair provisions might have been the result of poor advice on both sides.

    In my experience, for SME developers the advent of charging higher than peppercorn ground rent came about as a direct result of the Great Financial Crisis (misnomer – Greedy Banker’s Get Off Scott Free Crime Bonanza). Development funders threatened to pull the plug due, in many cases (as we now know) resultant of over-dramatic/purposefully/aggressive low devaluations causing breach of LTV covenants, combined with unjustified devaluations by surveyors employed by mortgagees. One example I recall very clearly was the same valuation surveyor acting for two mortgagees who down-valued the same property by 10% in the space of about one week. When challenged, he said the Bank had issued a private instruction to devalue. Developments became unviable and SME developers fell like leaves in autumn. Two shocking statistics: in 1998 there were 12,500 SME house builders who delivered 40% of the UK’s new homes, by 2017 it fell to just 2,500 and 12%. A third went out of business between 2007 to 2009 (I fear without a capital support programme from HMG, when Covid19 and Brexit are replaced by the next crisis, the number will have reduced further). It was a funder who first recommended to us that charging greater than peppercorn ground rent was the appropriate way to redress devaluations and thereby funding. The rationale being that the buyer benefited from a lower capital price, partly paid for by capitalising the value of ground rent. We had no experience in ground rent regime and relied on our solicitors at the time to provide advice on how to structure the lease. Thankfully, our leases fell on the fair side of the fence.

    In the press, all developers gets tarred by the same the brush. It appears in many cases that unfair and unreasonable (profiteering) provisions were used by large Plc builders who have a tight control of the market and enjoyed a massive boom since 2012. Incidentally, Plc. Builders have also taken the lions’ share of HtB funding. An unrelated gripe, the fund set up by HMG to assist SME builder’s (Home Development Fund, operated appallingly by Homes England) has failed dismally due to red tape and HE’s unofficial preference to fund schemes of developments of 80+ units (i.e. they don’t really like using the SME fund to finance SME schemes).

    To my mind, the problem of unfair leases results from a few (mainly large) bad apples, which the market can address/has addressed: 1. Mortgagees will not now accept ground rent of more than 0.1% of capital value nor unfair review or service charge regimes. 2. Help to Buy does not allow ground rents. 3. The legal profession (I hope) is fully alive to the risk and will advise clients accordingly, the same applies to IFAs. 4. The customer base is now aware of the risk of unfair leases, as are developers (particularly SMEs).

    I agree with your view that replacing a system abused by the few is unwarranted. One danger is that the new system will cause confusion and thereby cause yet more instability in the market (for flats) which is already suffering from Brexit and Covid19.

    As an aside, perhaps HMG should look at its own backyard: Appreciating that HtB is possibly the most important influence in the new-build market, it is inherently unfair because the buyer underwrites HMG’s downside risk yet shares upside passi passu. Worst still, the outrageous interest charged on student loans and rip-off student accommodation.

    Duncan Crook, Ressance

  2. D S says:

    Thanks for the post Raymond. My responses in order of your post:

    Cladding – you raise a fair point that it seems like a huge burden on home owners to bear the cost of replacing the cladding, whilst necessary to get done, the cost should be shared between councils, builders as well as home owners.

    Service Charges – the system is complex and for the unfamiliar buyers they may not recognise how much the management company is absorbing as their fees. Education from their legal representation should be a necessary part of the conveyancing process. I am of the same view with regards to the need for a common service function that manages the block, whether its managed by the individual owners as a community or outsourced to a dedicated management company. It can be deemed unfair when the management company has unreasonable fees, however, the leaseholders have the option to set up an RTM company. You also discuss the implications of management by the flat owners that could be negative because everyone has their own interests and have differing budgets – is there a set of minimum standards here that should be met.

    Doubling of Ground Rents – Fortunately this is banned now and so avoids people falling into the same trap and having a flat which becomes unsaleable.

    Legislation changes – The new proposals would benefit leaseholders at the expense of the freeholders significantly. If a freeholder has invested a large sum of their wealth into the freeholds with an expected cashflow over the lifetime of the investment, they could be materially out of pocket. How will they be compensated. Could the new legislation allow for these freeholders vs those that have freeholders that haven’t had to invest any money – in theory sounds great but likely difficult to implement in practice

    Thanks for sharing your thoughts and views on the matter. I do have some questions which build on what you have said, in a block of flats is the RTM or the terms of the lease allowed to enforce having no pets. How would one go about challenging this? If the pet adheres to the terms of the lease e.g. no noise before 8am or after 10pm wouldn’t its rights be the same as us?

    • Thanks to DS for his interesting comments. I will respond in the same form:

      Cladding – it is indeed a huge burden. Although it has raised massive interest because of the Grenfell tragedy and the potential effect on health and safety in many other blocks, under the terms of most leases it would be treated in the same way as any other major repair; the only two candidates for paying for it are the tenant and the landlord and which of the two, as I have pointed out, depends on the terms of the lease (it’s usually the tenant). I agree, though, both because of the health and safety aspect and the number of buildings involved, others should contribute some or all of the cost and that is most likely to be the government (which has taken some steps already). Some major developers have also taken on board the cost, even though they have been technically entitled to claim a refund from the tenants (and Barratt is supporting the creation of a developers fund)..

      Service Charges – I agree that these can be complex. The simple fact though, in the case of flats, is that the structure, exterior and common parts have to be repaired and maintained (whether the controller of the common parts is a third party landlord or a residents company) , and it is fair for the tenants collectively to pay. Legislation has already placed requirements in relation to management and fairness, enforceable by the First-tier Tribunal. In addition, there is the Service Charge Residential Management Code published by RICS. There would be room here, I think, for a consolidation exercise leading to a widely accepted standard form of lease (rather like the Model Commercial Leases).

      Doubling of Ground Rents – as you say, this is now banned and if the current proposals of the government are implemented, ground rents generally will suffer the same fate.

      Legislation changes – I agree with what you say. I suspect the answer to your question “how will they (the freeholders) be compensated” is not at all. The attitude behind the government’s new proposals appears to be that marriage value is some kind of fiction to increase the price payable by lessees. It isn’t of course but I would be very surprised to see any proposal for landlords to be compensated – and who would pay?

      You asked entered a question about pets. Pets are frequently prohibited in flats. The key is the lease terms. If there is an RTN company, no doubt relaxation of any covenants could be negotiated but it would be complex. The same would apply after collective enfranchisement, although there would be more flexibility under the agreement between the qualifying lessees and the nominated company. I doubt the practicality of specifying hours.

      RC

  3. PS. Just before I posted this, I read a perfect example of the kind of misleading press comments I referred to. This is from [this morning’s] Sunday Times editorial, headed “Housebuilders to account and resolve this housing scandal”:

    “That scandal has produced worry and heartache for millions of people living in leasehold flats with unsafe cladding”.

    All other mentions of the victims use the word “leaseholders”. Nobody with a heart could fail to agree with the words quoted, but, as I pointed out in my post, what readers will take from this is that only the owners of leasehold flats are affected and, therefore, that the leasehold system is to blame; when in fact any owner of a flat or house, whether freehold (including commonhold) or leasehold, would have to pay for the repair work, as nobody else would.

    Raymond Cooper

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