Leasehold: we have a problem

The purchase of a property, be it a house or a flat is, for many, an exciting milestone.

The number of new flats across the country looks set to increase due to buyer demand and rises in population. A prudent buyer (and their solicitor) will have significantly more potential issues to take into account when purchasing a leasehold flat compared with a freehold house – issues which could quickly bring a transaction crashing back down to Earth.

Space for improvement
The buyer of a flat will often purchase with the intention of carrying out works or alterations once they have moved in, particularly following increases in working from home. A lease will usually impose restrictions limiting the ability of leaseholders to carry out such works. It is important to ascertain that the terms of the lease will not be unduly restrictive. It is common for internal non-structural alterations to be allowed subject to the consent of the landlord acting reasonably (known as a “qualified” restriction), but for external or structural alterations to be prohibited meaning that a landlord does not have to consent to such works (an
“absolute” restriction).

Whereas landlords may have previously overlooked an absolute restriction and, for example, consented to a scheme that included an element of structural works such as cutting into a structural wall, the Supreme Court decision in Duval v 11-13 Randolph Crescent Ltd [2020] UKSC 18; [2020] EGLR 17 now means that a well-advised landlord may not consent to such alterations without first obtaining the consent of any flatowners within the building who have the benefit of a lease containing a “mutual enforceability covenant” (a common landlord covenant to enforce covenants given by other tenants in the building). This can be a time-consuming and costly process, and there is no guarantee consent will be forthcoming.

Alienation
Bearing no relation to Area 51, “alienation” means the transfer of the ownership of property rights, ie the ability of the leaseholder to assign (sell), underlet or charge their interest. It is common for a lease to restrict such dealings. A formal landlord’s licence may be required and the landlord may require references, financial accounts and even guarantees or deposits before agreeing that a lease can be sold or underlet.

The lease may also limit the tenant’s ability to let the flat as a holiday or Airbnb letting. In Nemcova v Fairfield Rents Ltd [2016] UKUT 303 (LC), the tenant’s lease restricted the flat from being used otherwise than as a private residence.

While this did not mean the tenant must use the property as their own private residence, it was held that, to be the occupier’s private residence, “there must be a degree of permanence going beyond being there for a weekend or a few nights in the week”, and therefore the use of the property for short-term lettings constituted a breach.

Ground control to major works
The ownership of common parts and structural areas not demised to neighbouring owners (such as the foundations, roof, lifts, bin stores, gardens or car parks) will remain with the landlord. As such, a landlord is commonly responsible for maintaining and repairing those parts of the building.

The landlord will usually collect payments from the leaseholders to cover such expenditure by way of a service charge. At the start of each financial year, the landlord will predict the level of outgoings anticipated in the upcoming 12 months, and will collect from each leaseholder either a fixed percentage of that amount, or a variable “fair and reasonable proportion” (according to the lease provisions). This ensures that the landlord has sufficient funds available when the time comes to carry out the required works, and enables them to refuel their finances at the start of each year.

However, emergency works to the building may arise without warning and may therefore be unaccounted for, or otherwise there may be planned major works requiring a significant increase in the contributions payable by each leaseholder.

Any increases in service charges must be reasonable, and leaseholders can challenge service charges if they don’t consider that the reasonableness test is satisfied. Landlords are also required to consult with their leaseholders if the annual contribution is expected to increase by more than £250 per owner, by following the process prescribed by section 20 of the Landlord and Tenant Act 1985.

Rocketing ground rents
In order to retain some value in a block after granting long leases of the flats, landlords will often require leaseholders to pay an annual ground rent. Usually, the amounts will be relatively small (in comparison with the value of the flat), but can prove to be a useful commodity for landlords. The ground rent may be set to increase periodically to counteract rises in inflation. However, there has been a recent trend towards landlords seeking to use ground rents to achieve greater gains to increase the value of their reversionary interest with, for example, ground rent doubling every 10 years. While this does not initially sound unreasonable, the calculations must be checked carefully – an initial annual ground rent of £200 doubling every 10 years will require an annual payment of £1,638,400 after 130 years – an astronomical sum.

In 2021, the government issued draft legislation, by virtue of the Leasehold Reform (Ground Rent) Bill, with a view to effectively abolishing ground rents on newly created long leases of houses and flats. However, the bill, which was granted royal assent on 8 February, will apply only to new leases rather than older ones.

Who’s in control?
While a landlord will retain ownership of the reversionary interest in a lease, meaning the property reverts to them once the lease “runs out”, it is common for practical day-to-day responsibility for the block to be passed to a management company, often managed by the leaseholders themselves. This allows leaseholders to exercise control over their own expenditure, to enable them to steady the ship in terms of service charges and major works.

The leaseholders will often be required to become shareholders in the management company, and to pass their shares to future buyers on an assignment of the lease. This gives rise to additional responsibility and, while the additional level of control is beneficial, it is important to ensure the company is properly run by the leaseholders and that decisions are proactively reached when works are required.

The Commonhold and Leasehold Reform Act 2002 introduced a new right to manage for the benefit of residential leaseholders, enabling them to regain control of the management of the building from the landlord. This is commonly exercised in circumstances where leaseholders are unhappy with the performance of their current landlord.

While the landlord would still be able to collect ground rent after an RTM company takes control, their level of involvement and decision-making will be eclipsed by the leaseholders.

Permission granted?
As discussed above, some dealings with a leasehold property, such as assigning the lease, granting underlettings or carrying out alterations, cannot be commenced or completed without first obtaining the consent of the landlord. Where the landlord’s consent is required, it should be expected that the landlord will charge a reasonable fee and this can include related professional fees such as legal fees.

Re-entry (and other rights)
As the lease will contain the fundamental provisions relating to the tenant’s enjoyment and use of the property, it is crucial to consider whether adequate rights are granted, and covenants imposed. The UK Finance Mortgage Lenders’ Handbook for Conveyancers sets out some general provisions that we would expect to be included in all leases, namely rights for access, services, support, shelter and protection, and obligations on the landlord to be responsible for repairing and insuring the building, and to allow the tenant peaceful enjoyment of the property
without re-entry or interruption from the landlord.

Although a buyer may be happy to proceed with their purchase of a lease in the absence of those provisions, a mortgage lender would not necessarily share the same risk appetite and may require variations to the lease in order to proceed.

Consideration should also be given to the ability of a future buyer to obtain mortgage finance so the property can be resold. In practice, if you are considering buying a leasehold flat, you should obtain expert legal advice in order to avoid potential pitfalls and ensure that your purchase is cleared for launch.

This article was first published by Estates Gazette on 26 March 2022.