Leasehold property has been in the spotlight over recent years, culminating in the recent release of the Government’s review into unfair practices. However, notwithstanding the negative press, leasehold property remains popular for both home owners and investors alike. Data from the Ministry of Housing suggests that across England, there are now 4.3 million leasehold homes (with two thirds being flats and one third being houses) of which, approximately 2 million are rented in the private and social sectors.
The critical thing to remember is that leaseholds themselves aren't necessarily the issue, it's "bad leases" that are the issue. Anyone considering a leasehold purchase should take into account the following;
1. Understand what leasehold is.
Leasehold title means that, for a period determined by the lease, there is a temporary right to occupy land or property. Leaseholders get exclusive possession of the property for a fixed period, but do not actually own anything in the eyes of the law. Unless the lease is extended, when it ends, ownership returns to the freeholder. Of course, this seldom happens, as leaseholders have a statutory right to extend their leases, albeit at a cost.
2. Duration of the lease
A lease is a depreciating asset and the price paid should reflect the number of years left on the lease. A lease that falls below 80 years will be challenging to mortgage and increasingly expensive to renew. The first question that any purchaser of leasehold should ask is, what is the duration of the lease and, where an extension is appropriate, ensure they budget for the cost of such extension.
3. Ground rent
Possession of leasehold property is subject to the payment of an annual ground rent. The ground rent may be fixed for the remaining lease term, or subject to periodic increases (escalations). Buyers should be wary of both high ground rents and punitive escalation clauses. Where ground rents become greater that 0.2% of the market value of the property, future mortgageability and saleability become a concern.
4. Understand the lease
The relationship between the leaseholder and the freeholder is substantially governed by the lease contract (although there are numerous legislative provisions that also govern the freeholder-leaseholder legal relationship). Leasehold purchasers should always seek appropriate legal advice to understand the terms of the lease. Some of the key considerations are;
- Does the lease have a “maintenance covenant” that places an obligation on the freeholder to maintain the building and common areas? Without such requirement, leasehold properties can fall into a state of disrepair and again, become challenging to mortgage and sell.
- Determine what rights and obligations are granted under the lease. In particular, watch for lease terms that could affect how you might choose to use the property. For example, are there restrictions on the ability to keep pets, operate a business from the property or sublet the property. Also, are there any age or occupancy limitations imposed?
5. Understand the costs
There are a number of costs associated with leasehold ownership including ground rents, maintenance charges, administrative fees (for various freeholder consents and approvals) and the potential cost of extending the lease. Such costs should be built into budgets of home owners and investors alike. Service charges in particular are a common source of frustration and anxiety for leaseholders, as such charges are set by the freeholder and can be difficult for leaseholders to plan and budget for. Potential leasehold purchasers should always request information regarding historical service charges to understand the frequency and extent to which they fluctuate.
6. Condition of the property
Before purchasing a leasehold, a thorough inspection should be undertaken to understand the extent to which the building is adequately maintained. Enquiry should be made about planned future expenditure and whether a “reserve or sinking fund” is being accrued to cover future works. Any property in a state of disrepair with no reserve fund should be a cause for concern.
7. Relationship with the freeholder
A difficult freeholder (or managing agent) can make leasehold ownership challenging. While both the lease and legislation can provide a degree of protection from rogue freeholders, having an acrimonious relationship will undoubtedly impact the enjoyment of leasehold ownership. Where possible, buyers should try to talk to existing leaseholders to gain insight into how the freeholder (and their managing agent) operates.
8. Specific considerations for investors
Investors in leasehold property should give further consideration to;
- Is sub-letting permitted under the lease?
- If sub-letting is permitted, what are the constraints? No holiday letting, single families only, letting of the whole of the property and not it part etc.
- Are other restrictive covenants in the lease going to limit the pool of potential tenants, eg no pet policies, occupancy restrictions etc.
- Ensure that yield calculations take into consideration maintenance charges, ground rents and the like. Taking account of these additional costs, leasehold gross yields should be discounted by approximately 20% before they can be realistically compared to freehold yields.
- Leaseholders who sublet should be aware of their obligations for repairs under S11 of the Landlord and Tenant Act 1985.
The key thing to remember is that leaseholds themselves aren't necessarily the issue, it's bad leases that are the issue. Notwithstanding any future legislation, careful due diligence and a thorough evaluation of both lease and property should go a long way to ensuring that any leasehold purchase is successful.
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