What you need to know about buying a leasehold property
Owning a leasehold property is usually more complex and more costly than a freehold. Here's what you need to check before making an offer.
What is Leasehold?
A lease is essentially a long-term rental agreement - typically between 99 and 999 years.
A lease is issued by a freeholder (landlord) for a fixed term. Once the term expires, the leaseholder loses the right to use the property and ownership of the lease will revert to the freeholder.
Most flats in England and Wales are leasehold. However, the past few years have seen an increase in the number of leasehold houses.
How is leasehold different from freehold?
If you own a freehold property you own the building and the land on which it is built. As a freeholder, you will own the property and land in perpetuity.
With leasehold, you own the right to use the property (in accordance with the lease) until the lease either expires or is extended.
There will also usually be annual charges including service charges and ground rent, as well as administration fees. If these charges are not paid then the lease could be forfeited which could, ultimately, lead to the leaseholder being evicted.
What are service charges?
Service charges are fees charged annually (usually) by the freeholder to cover the freeholder’s cost of maintaining the property, communal parts and grounds. Service charges may also be used to contribute to a 'reserve fund' or 'sinking fund' that would be used to pay for any major works in the future, such as a new roof.
What is ground rent?
Leaseholders will usually have to pay an annual rent known as ‘ground rent’ to the freeholder or landlord.
Ground rent is an amount paid to the freeholder to rent the land that the property occupies.
The lease will set out the amount of ground rent, and when and how frequently it must be paid. Ground rent is usually a nominal amount, £100 a year for example.
However, ground rents can be substantially higher. Excessive ground rents are of particular concern with the growing number of new-build leasehold houses that contain clauses allowing for a periodic ground rent review. In some cases, rent can be doubled every 10 years. This is known as 'spiralling ground rent' and your conveyancing solicitor will need to scrutinise this clause in detail.
What are administration fees?
Freeholders often charge administration fees for ‘services’ provided in conjunction with the buying, selling and owning of the leasehold.
For example, sellers will be expected to pay for management information that the freeholder will need to provide to a buyer during the conveyancing process. This information will include details of service charges, disputes and any planned major works.
Some leases require the seller to obtain a ‘licence to assign ‘ which enables the seller to pass the leasehold onto the buyer.
Details of any administration fees should accompany the lease.
Should I obtain a copy of the lease before making an offer?
A copy of the lease is not usually included with the particulars of the property during the sale process. This is surprising, considering it is technically the lease that you are purchasing, not the property itself.
As the lease includes details of the associated rules and costs of living in the property, it would be helpful to see the lease before you make an offer.
Most buyers only receive a copy of the lease during the conveyancing process, possibly 4 to 6 weeks after the offer is accepted. If the lease contains clauses that you are not prepared to accept, you will have wasted time and money.
Ask the estate agent for a copy of the lease before making an offer. You should then read the lease or, better still, ask a conveyancing solicitor to do so. As most solicitors work on a no sale, no fee basis, there is no downside to instructing a solicitor before your offer is accepted.
If the agent, or seller, is unable or unwilling to provide a copy of the lease, you can obtain a copy from HM Land Registry.
Will I be able to extend the lease?
As a leaseholder, you have certain rights that entitle you to extend your lease:
If you have owned your lease for two years or more, you have the right to enter negotiations with the freeholder to extend your lease. This process can be done either informally, or by following a formal process.
If you follow the formal route your lease will be extended by 90 years for a premium agreed with the freeholder. If a premium cannot be agreed upon following a professional valuation, the leaseholder could ultimately take the freeholder to the 'First-tier Tribunal (FTT)' (formerly the 'Leasehold Valuation Tribunal (LVT)').
It is highly advisable to extend your lease before it falls below 80 years. The reason for this is that when the lease drops below 80 years then the freeholder can also ask for 50% of the property's 'marriage value’. Marriage value is the estimated amount of extra value that would be added to the property by extending the lease.
If the lease falls below 70 years it will be harder to obtain a mortgage. Below 60 years it will be nearly impossible to obtain a mortgage. It will consequently be very difficult to sell the property with an unexpired lease term of fewer than 60 years.
Practically speaking if you’re a leaseholder with fewer than 90 years to run on your lease, you should be thinking about extending if you can.
Buying a leasehold
If you’re buying a leasehold property the section above explains your rights to extend, after you buy the property.
The critical point is that once you become the new owner you will have to wait two years before you can start the formal process of extending your lease. If the lease you are buying only has 82 years to run, then you could find yourself having to pay marriage value when you extend.
Is there a workaround so I don't have to wait 2 years?
Yes. There is a workaround which your conveyancing solicitor should be familiar with. If you ask the seller to serve a formal 'Section 42 Notice' to begin the lease extension process, the seller can then assign the right to continue that process to you as the new owner. This approach bypasses the need to wait two years for the right to start the lease extension process.
What is a 'Share of Freehold (SOFH)'?
Owning a share of the freehold is when a leaseholder also owns a share in the freehold.
The share of freehold can be set up in one of two ways:
- The freehold is held in a company structure and the leaseholder owns shares in the company
- The freehold is divided directly into shares and held personally by the leaseholder
Will I be able to buy the freehold?
Under the process of ‘Collective Enfranchisement’, leaseholders have the right to acquire the freehold of their properties, providing certain criteria are met. This right has existed since 1993 but was further clarified by the ‘Commonhold and Leasehold Reform Act 2002’.
The criteria to qualify for collective enfranchisement are:
- Eligible tenants must own leases with over 21 years to run
- The block must contain two or more flats that are owned by eligible tenants
- Two-thirds of the flats must be owned by eligible tenants
- 50% or more of the tenants need to participate in the process
If you are acquiring the freehold with fellow leaseholders, then you are acquiring a share in that freehold in addition to owning the lease. The freehold will need to be held in the form of individual shares or, more commonly, in a management company set up to manage the freehold.
The terms of the lease will still apply and must be adhered to by the leaseholders and the freehold company. However, this arrangement is usually preferable as it gives the leaseholders a greater degree of self-determination over how the block is managed.
Properties with a share in the freehold will be easier to sell and will command a premium.
There will of course be a cost involved in acquiring the freehold and it may work out cheaper to extend the lease.
The disadvantages of owning a leasehold property:
- A lease is essentially a long-term rental agreement. When it expires you would have to approach the freeholder to purchase a new lease which can be expensive. The freeholder does not have to consent to grant a new lease.
- You will have to pay service charges, ground rent and other fees. Although there are rules governing the setting of service charges, the process is open to abuse by unscrupulous freeholders.
- The lease will contain conditions that set out how you can use the property. For example, you may not be able to sublet it or keep pets.
- If the lease is short (< 80 years) it will be difficult to mortgage and sell.
- If you want to modify or extend the property, you will usually need the permission of the freeholder. This could incur substantial fees and the freeholder may refuse.
I have heard leasehold described as a 'declining asset' - what does this mean?
A key point to remember is that the value of a leasehold property will depreciate over time. This is known as a 'declining asset' or ‘wasting asset’.
The way in which leasehold properties depreciate is non-linear and can be confusing.
When the lease expires (i.e. there is no time left to run on the lease), it is technically worthless. However, this does not mean that an initial lease of 100 years has depreciated by a linear 1% per annum.
There are several milestones in the term of the lease where depreciation accelerates e.g. when the unexpired lease term falls below 80 years, marriage value will apply. With around 60 to 70 years remaining, it will be hard to obtain a mortgage.
The advantages of owning a leasehold property:
- Leasehold properties are usually more affordable to buy than freehold
- If you have any noisy or problematic neighbours, you can complain to the freeholder. The freeholder is then obligated to take action in accordance with the terms of the lease.
- The freeholder, or their managing agent, should maintain all the communal area and gardens for you.
- Buildings insurance will be taken care of by the freeholder or landlord for the whole block. The cost of the policy will be shared by all leaseholders.
If you are buying a flat it will be a leasehold property. Although there has been bad press surrounding leasehold, it allows for a block of multiple flats to be managed in the collective interest of the leaseholders. The fact that the property is leasehold should not deter you from buying a property.
A leasehold proficient conveyancing solicitor will investigate whether there are any areas for concern and advise you accordingly.
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