Leasehold Ground Rent Reform – What does this mean for developers?

Developers selling new leasehold properties, and landlords with existing stock should be aware of the following key changes proposed by the Bill:

• Rents to be reduced to a nominal peppercorn amount in most long residential leases which are granted after the Bill becomes law.
• Leases agreed and subject to an agreement for lease prior to the Bill coming into force will not be subject to the new rent provisions but care should be taken if amending existing contracts as any variation after the Bill becoming law will be affected by the new ground rent requirements.
• Variation to leases which result in a surrender and re-grant occurring after the Bill comes into force will be subject to the requirement for peppercorn rent.

This is the first in a series of long awaited legislative measures seeking to fundamentally change the way in which ground rents are applied to residential premises with the intention that it will lead to a “fairer, more transparent home ownership for thousands of future leaseholders”, and while this is the intention, the Bill also poses significant changes for developers and landlords. For example, the Bill does not refer to “ground rent” and instead is intended to apply to all “rents” reserved by residential long leases. At face value this may seem to be an arbitrary piece of drafting, however, it means that other sums which are typically reserved as rent in a lease (including sums due for service charge and insurance rent) may also be impacted inadvertently and will require close attention when leases affected by these changes are drafted to avoid service charges and other legitimate costs being caught by the cap.

Developers will be relieved to note that the Bill will not apply retrospectively, but it is envisaged that it will apply to surrender and re-grants after the date of the Bill coming into force. This means that any variation to a lease which would deem surrender and re-grant (such as a change to the extent of the demise or to the term of the lease) would be subject to the terms of the new proposals. Minor variations to leases (such as permission to make internal alterations or to allow the keeping of pets) would be unlikely to require a reduction in ground rent to a nominal peppercorn provided that these variations to not trigger a deemed surrender and re-grant. Landlords of residential until should therefore be alert to any variation that might need to be made to leases within their portfolios in advance of any change to ground rents. 

It should also be remembered that existing leasehold enfranchisement legislation allows leasehold owners to extend their lease term and reduce ground rent to a peppercorn provided that they satisfy the statutory pre-requisites and subject to paying the Landlord the requisite premium. The retention of this mechanism for existing long leases may unwittingly create a two-tier leasehold market. 

Additionally, the Bill would not apply to leases which are entered into following an agreement for lease that was entered into before the legislation is introduced (April 2023 at the earliest). Developers who have developments that will reach practical completion after the Bill becomes law will no doubt with to agree early sales to ensure that the leases for the whole development can remain consistent as far as possible. 

These changes will not come as a surprise to those who have been following the market commentary. The rules applying to the new Help to Buy scheme already requires peppercorn ground rents on any dwelling being purchased using the Help to Buy scheme.

While the Bill contains some exemptions, including for Islamic finance and equity release schemes, home business leases which govern the occupation of a premises for both residential and business purposes, and certain areas of the community-led housing sector, these exemptions are of limited application for most residential developers.

The reduction in ground rents to a peppercorn will continue to impact the market value of freehold reversions, and any non-compliance by landlords could result in financial penalties of £500-£5,000 per lease (meaning that penalties could become substantial if a large block is found to be non-compliant). 

This is only one part of a wider package of proposed measures to shake-up the leasehold sector, with additional changes relating to lease extension terms, the abolition of marriage value and online calculators for lease extension all expected to become law in due course. 

BT COMMENT – The changes to ground rent provisions have been on the Government’s agenda for some time so these changes will not come as a surprise. We have found that many developers involved with smaller schemes have embraced the changes and voluntarily granted 999 years at a peppercorn ground rent with a view to maximising marketability of the units rather than reserving modest value within the residual freehold interest. It will be interesting to see whether the changes will have a material impact on the value of existing ground rent investments as the pool of those assets ceases to expand. 

There is also a risk that the proposed changes to ground rents may also affect the marketability of existing “second hand” leases with existing ground rent provisions which may be adversely affected when competing with newer leases with peppercorn rents with the potential for creating a two-tier leasehold market. 

Developers selling new leasehold properties, and landlords with existing stock should be aware of the following key changes proposed by the Bill:

• Rents to be reduced to a nominal peppercorn amount in most long residential leases which are granted after the Bill becomes law.
• Leases agreed and subject to an agreement for lease prior to the Bill coming into force will not be subject to the new rent provisions but care should be taken if amending existing contracts as any variation after the Bill becoming law will be affected by the new ground rent requirements.
• Variation to leases which result in a surrender and re-grant occurring after the Bill comes into force will be subject to the requirement for peppercorn rent.

This is the first in a series of long awaited legislative measures seeking to fundamentally change the way in which ground rents are applied to residential premises with the intention that it will lead to a “fairer, more transparent home ownership for thousands of future leaseholders”, and while this is the intention, the Bill also poses significant changes for developers and landlords. For example, the Bill does not refer to “ground rent” and instead is intended to apply to all “rents” reserved by residential long leases. At face value this may seem to be an arbitrary piece of drafting, however, it means that other sums which are typically reserved as rent in a lease (including sums due for service charge and insurance rent) may also be impacted inadvertently and will require close attention when leases affected by these changes are drafted to avoid service charges and other legitimate costs being caught by the cap.

Developers will be relieved to note that the Bill will not apply retrospectively, but it is envisaged that it will apply to surrender and re-grants after the date of the Bill coming into force. This means that any variation to a lease which would deem surrender and re-grant (such as a change to the extent of the demise or to the term of the lease) would be subject to the terms of the new proposals. Minor variations to leases (such as permission to make internal alterations or to allow the keeping of pets) would be unlikely to require a reduction in ground rent to a nominal peppercorn provided that these variations to not trigger a deemed surrender and re-grant. Landlords of residential until should therefore be alert to any variation that might need to be made to leases within their portfolios in advance of any change to ground rents. 

It should also be remembered that existing leasehold enfranchisement legislation allows leasehold owners to extend their lease term and reduce ground rent to a peppercorn provided that they satisfy the statutory pre-requisites and subject to paying the Landlord the requisite premium. The retention of this mechanism for existing long leases may unwittingly create a two-tier leasehold market. 

Additionally, the Bill would not apply to leases which are entered into following an agreement for lease that was entered into before the legislation is introduced (April 2023 at the earliest). Developers who have developments that will reach practical completion after the Bill becomes law will no doubt with to agree early sales to ensure that the leases for the whole development can remain consistent as far as possible. 

These changes will not come as a surprise to those who have been following the market commentary. The rules applying to the new Help to Buy scheme already requires peppercorn ground rents on any dwelling being purchased using the Help to Buy scheme.

While the Bill contains some exemptions, including for Islamic finance and equity release schemes, home business leases which govern the occupation of a premises for both residential and business purposes, and certain areas of the community-led housing sector, these exemptions are of limited application for most residential developers.

The reduction in ground rents to a peppercorn will continue to impact the market value of freehold reversions, and any non-compliance by landlords could result in financial penalties of £500-£5,000 per lease (meaning that penalties could become substantial if a large block is found to be non-compliant). 

This is only one part of a wider package of proposed measures to shake-up the leasehold sector, with additional changes relating to lease extension terms, the abolition of marriage value and online calculators for lease extension all expected to become law in due course. 

BT COMMENT – The changes to ground rent provisions have been on the Government’s agenda for some time so these changes will not come as a surprise. We have found that many developers involved with smaller schemes have embraced the changes and voluntarily granted 999 years at a peppercorn ground rent with a view to maximising marketability of the units rather than reserving modest value within the residual freehold interest. It will be interesting to see whether the changes will have a material impact on the value of existing ground rent investments as the pool of those assets ceases to expand. 

There is also a risk that the proposed changes to ground rents may also affect the marketability of existing “second hand” leases with existing ground rent provisions which may be adversely affected when competing with newer leases with peppercorn rents with the potential for creating a two-tier leasehold market.