On 24 May 2021 the Leasehold Reform (Ground Rent) Bill had its second reading in the House of Lords.
What is in this bill and what lies ahead?
The bill was announced in the Queen's Speech and is part of the government's wider package of intended leasehold reform detailed in our previous article (link here). It will ban ground rents in new long residential leases (over 21 years). On introducing the second reading, Lord Greenhalgh stated that it is intentionally narrow in scope and further legislative reform will follow. The context is the government's manifesto commitment to improve the leasehold system for homeowners.
The scope may be narrow, but the drafting is wide. There are likely to be amendments before it comes into force but, as it stands, it prohibits the charging of 'rent' including "anything in the nature of rent, whatever it is called" on any new lease of a dwelling over 21 years in length. There are limited exceptions, such as for (a) the community led housing sector, (b) leases that are part of financial products yielding rent instead of interest and (c) home business leases. Unless an exception applies, the ground rent in any new long residential lease will be set at one peppercorn per year.
Lord Greenhalgh made the point that the definition of 'rent' is deliberately wide but it is not intended to capture payments for maintenance or other services. In practice, amendments are likely to be needed to make that clear. Further, time will tell, but it may affect the practice of reserving service charge and insurance payments 'as rent' (which simplifies the forfeiture procedure in the event of arrears). Amendments are also needed to allow long residential leases at a nil premium and market rent. On a lighter note, Lord Greenhalgh did add that collection of the peppercorn is not obligatory.
Enforcement of the bill will be via trading standards authorities and/or local authorities. Fines of up to £5,000 can be levied if a prohibited rent is charged, together with an order for repayment and interest.
How will this affect commercial development and investors?
The effect of the bill will be wide ranging. At present, there is an investment market for ground rent portfolios. A quote from Lord Greenhalgh, "Institutional investors will be able to benefit from their existing investments, but in future they will find alternative investment elsewhere. I fully expect investors to adjust their business models to account for this change." Capitalised ground rent investments are often used to help fund construction. Developers and investors will need to adjust to a new normal where this funding source is no longer available from new long residential leases.
The retirement home sector will be particularly affected. Sale of a ground rent investment is a common source of funding for retirement home development. Early on the government had announced that the retirement housing sector would be exempt. This position has been reversed on the basis that older residents should also be freed from financial demands for ground rent. This sector will have extra time for the transition, with the bill not applying in this sector until 1 April 2023 at the earliest.
What about existing leases?
The bill is not retrospective. It will not affect existing leases, nor leases where the agreement for lease has been exchanged before the bill comes into force.
Early in the consultation process there had been talk of making the bill retrospective. There was concern that use of uncertain or unfair ground rents was on the rise (particularly doubling ground rents on short cycles) and that action was needed. However, it may be that the government preferred to let the Competitions and Markets Authority ('the CMA') tackle this issue rather than backdating the effect of legislation. In March 2021, the CMA requested two housebuilder firms, Taylor Wimpey and Countryside, to remove such provisions from their leases or face further action through the Courts. The housebuilders in question had already stated they had ceased this practice and would set aside funds to vary the leases. The CMA is still investigating other housebuilders. This is still playing out and in many cases it will be up to buyers (and their solicitors) to spot these terms and request a variation.
Leaving aside the issue of unfair/uncertain ground rent provisions, we still have an enormous number of existing leases in the market that contain ground rents. Looking to the future, we may find that a two-tier market develops, where leases that contain even modest ground rents are less appealing to buyers than new leases at a peppercorn.
Further, we may find that prices adjust. On purchase of a long leasehold interest the ground rents are part of the consideration - if they are set at a peppercorn then the premium for the lease may go up.
What happens next?
The government has made it clear that this is one part of their leasehold reform agenda and further legislation will follow. We can expect them to pick up on the remainder of the reforms announced in January covering enfranchisement valuation and 990 year extension leases (as detailed in our earlier article – link here).
We can also expect an increased focus on 'commonhold'. Legislation to allow commonhold ownership has been in force since 2004 but there has been very little take up in England and Wales. Many mortgage providers will not lend on commonhold. The government says it intends to reinvigorate commonhold and recently announced the launch of the Commonhold Council, a panel of leasehold groups and experts to advise the government on the future of commonhold, likely to include simplifying the system and promoting its use.
There will be plenty of changes to watch in this area and the effects, taken together, will be far-reaching indeed.
Institutional investors will be able to benefit from their existing investments, but in future they will find alternative investment elsewhere. I fully expect investors to adjust their business models to account for this change. Crucially, the benefit to future home owners will be significant.