Ground rent scandal

There has been a great deal in the news over the last few months about the next big financial scandal, this time in relation to ground rents.

Estimates suggest that around 100,000 homeowners in England are trapped in leasehold contracts with rapidly growing ground rent costs. Such has been the outcry that the Government are proposing legislation to reduce all ground rents to nil and ban the sale of houses as leaseholds. There are also discussions of compensation arrangements.

Cambridge has seen a real spike in residential developments that are being sold on a leasehold basis where the ground rents have a built in price ratchet that may catch buyers unaware.

In the past most newly built properties were sold as freeholds, so the buyer owns the building and the underlying land. However, it is possible for a house to be sold on a leasehold basis, usually on a very long lease of 125 years or more. The upfront leasehold price is typically similar to the cost of buying a freehold property, and then a smaller ground rent payment is made each year to the owner of the freehold. The freeholder may also have other controls over the leaseholder, for example with regards to property alteration whereby a payment needs to be made by the leaseholder before any changes can be made to the leasehold property.

In the past the ground rents were calculated on a “peppercorn” basis, with perhaps only a nominal payment of say £1 per year being due. However, more and more developers will now set the initial ground rents at a few hundred pounds per annum but there will be clauses in the lease which allow for automatic increases to be applied every few years. The rights to receive ground rents are often sold on to investment companies who are looking to take advantage of the clauses so that they will benefit from the future increases in the ground rents. Some clauses allow a doubling of the ground rent every 10 years, so starting with a £100 ground rent for a 125 year lease on a small two bedroom flat would result in an annual ground rent of over £400,000 by the end of the lease term.

These hidden charges mean that some leaseholders are finding themselves in the position of being unable to sell their homes due to the astronomical ground rents that will be payable by future owners. Leaseholders may want to purchase the freehold but these rights can be unaffordable due to the current high prices being paid by long term investors. There has been significant pressure put on the government to stop unfair clauses which automatically inflate ground rents.  Many leaseholders feel they should have been properly warned by their solicitors about these types of arrangements. A large proportion of buyers of new build leasehold homes may have used the solicitor recommended by the developer so it is possible that, due to conflicts of interest, these clauses were not properly highlighted.  Some developers are already making provision for compensation claims and it will be interesting to see how far the government is prepared to support buyers who have found themselves in this situation.

Local developers will need to take account of the likely changes ahead when building properties that include leasehold interest.

Comment

Judith Pederzolli

Assistant Director, Business Tax
I am an Assistant Director in PEM’s Business Tax department. As well as providing general business tax advice I have a strong focus on property taxes, including Stamp Duty Land Tax and the Annual Tax on Enveloped Dwellings. Another of my specialist areas is advising on the direct tax issues facing charities and non-for-profit entities.

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