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All is fair in land and law?

In July 2017, the government issued a consultation paper entitled “Tackling unfair practices in the leasehold market”. It followed a period during which the issue of residential leasehold law had become (and remains) highly topical and is once again politically charged.

In February 2017, the government had published a Housing White Paper – “Fixing our broken housing market”. This followed a House of Commons debate on residential leasehold held in December 2016 and the formation of an All-Party Parliamentary Group on leasehold reform and commonhold led by Sir Peter Bottomley MP.

So, what has caused the government to take up the issue of residential leases when it might be thought that it has more pressing matters to consider?

It is that certain builders and developers of houses (particularly in the north of England) have allegedly been selling those houses on leases with levels of ground rent which have a material impact on the value of the lease (including in some cases making the leases effectively worthless). How has this happened?

The ground rent market has grown substantially in recent years, fuelled by low interest rates and a desire, particularly among the insurance companies and pension funds, to find secure long-term income producing investments. The leasehold sector, particularly of new-build flats and houses, has provided a suitable answer to this desire. Developers and builders have seen this need as a way of obtaining a “second sale” on a development: the initial sale of a long lease at a ground rent of the new house or flat to (primarily but not exclusively) the first-time buyer and then, once all the houses or flats have been sold, a sale of the reversion to those leases, to the ground rent investor. The higher the ground rent that can obtained (without having a material impact on the initial price of the lease or at least without the initial buyer being aware of any such impact) the more attractive the “second sale” becomes to the investor. The investor’s interest is purely in the income and ensuring that that income is both long-term and secure.

Historically, builders and developers would see the sale of their houses as the sole financial reward for their development and would usually have been more than content to pass on the management responsibilities for an estate to the owners/lessees, once the last house was sold. In some cases, this might have been to the local authority but they have become less enthusiastic at adopting new build roads, drains etc where such adoption adds further to their already stretched finances.

The problem more recently is that builders and developers have discovered that leases can be drawn in onerous terms without, so it appears, those terms having a material impact on the initial sale price of the lease. The allegation is that some builders and developers have been selling leasehold houses as “virtual freeholds” without the buyers realising (or being made aware) that the leases contain onerous terms. Buyers (particularly first time buyers encouraged by successive governments to become home owners) and their advisors (very often recommended and paid by the builder or developer) are not always astute in either recognising the onerous terms or, even if they are, in advising on what their impact might be on value and marketability. Mortgage companies and their valuers have not helped by equally failing to recognise that onerous terms might have an adverse effect on value.

The consultation paper sought views on a number of proposals to address this problem. There are two radical proposals from the government. First, there should be a prohibition on the sale of all new-build houses otherwise than on a freehold basis. Secondly, there should be a limit (which may be nil) on the starting amount of and any future increases in ground rents on all new residential long leases (not limited to houses).

Although the government does not put forward any specific proposal as regards current leases which have already been sold subject to onerous ground rents, it is seeking views on how it may support the owners of such leases. It is also seeking views on what further topics should be considered for a more radical reform of the residential leasehold sector. This may well include the re-introduction of a different form of land ownership to more substantially address what are perceived to be the weaknesses of the leasehold system by providing for a system of land ownership where the individual flat (or unit) is owned in perpetuity and where the flat (or unit) owners collectively own and manage the building.

In 2002, the government legislated for a new form of land tenure: “commonhold”. It allows for the freehold ownership of a part of a building or site and communal ownership of the common areas, coupled with the ability mutually to enforce the rights and obligations within the building or site through a system of democratic management in the hands of the owners. It was an abject failure because of wholly inadequate drafting which led to developers and mortgagees rejecting it. However, the government is likely to revisit this form of tenure to see what needs to be done to it to make it acceptable.

The response to the consultation has been considerable (it closed on 19th September 2017) and the government will no doubt want to take time to consider those responses. The track record of successive governments legislating in the area of leasehold reform is not a good one. The concern, based on past experience, is that any legislation may, if not carefully considered, have unintended consequences and unfairly penalise those responsible landowners who neither abuse the system nor mis-sell nor misrepresent their products.