Beware of freeholders bearing gifts – The truth about the Government’s freeholder pledge

fullsizeoutput_10f0Freeholders launch clandestine plot to outflank leasehold reform and make millions of homes unsellable

On 28 March, the Government announced a voluntary industry pledge which, it naively believes, will be enough to end the suffering of thousands of leaseholders trapped in a leasehold nightmare.

Cooked up with the largest property developers and freeholders in the land, the Government-backed pledge promises to end the exploitation of leaseholders.

Indeed, the very people responsible for inventing exploitative tools like doubling ground rents, service charges and permission clauses – which create untold hardship and misery to leaseholders – have finally ridden to the rescue, committing to free existing leaseholders trapped in onerous deals and stating that freeholder abuses have gone on long enough.

The Communities Secretary, James Brokenshire MP, said: “Since becoming Communities Secretary, I have repeatedly made clear my ambition to end those exploitative and unfair leasehold arrangements that have no place in a modern housing market.”

Housing Minister, Heather Wheeler MP, was also pleased with herself: “We want to make sure we have a leasehold system where people are able to challenge exorbitant rates and high service charges. It is unacceptable that the burden of legal fees – potentially running into tens of thousands of pounds – is preventing people from seeking justice. The plans announced today will stop leaseholders from picking up the tab for unjustified legal costs – creating a housing market that truly works for everyone.”fullsizeoutput_10f3

Thank goodness freeholders have finally found their humanity. It may have taken them a while but now they’re committed to sorting the whole mess out for every leaseholder in the land…

Hold your horses. Not so fast…

As we’re going to find out, this voluntary pledge is just a smoke and mirrors exercise to lull us all into a false sense of security. Behind the scenes, sinister forces are gathering to cement freeholders’ interests and outflank the leasehold reform agenda.

The consequences could cost leaseholders tens of thousands of pounds each and could leave millions of leasehold houses unsellable.

Housing Communities and Local Government Committee Chair, Clive Betts MP is right to distrust the scheme. He said: “Despite the catalogue of problems highlighted in our report, they (the Government) have chosen to trust the developers and freeholders who created these onerous leases in the first place to decide how to make the system fair.

“Given the evidence we heard from leaseholders during our inquiry, we know it will be difficult for them to trust developers and freeholders to deliver on such pledges anyway.”  

Clive Betts is right to raise the issue of trust. How can any rational leaseholder, looking at the way they have been exploited for decades, possibly believe the freeholders now have their best interests in mind? As ever, freeholders are only interested in three things: Profit, profit and yet more profit.

What is the truth about onerous ground rents right now?

fullsizeoutput_10f5Understanding valuation is vital, so let’s take a quick look at how we calculate the cost of a lease extension or freehold acquisition.

Many of the homes with onerous ground rents caught in the ‘leasehold houses scandal’ tend to have long leases. This means when we calculate the cost of buying the freehold, the only calculation we need to make is to compensate the freeholder for their loss of ground rent when the house is enfranchised.

For this calculation we have just one variable that must be agreed between the leaseholder and the freeholder; this is the rate of compensation used to calculate the loss of future ground rent.

This is known as the capitalisation rate (Cap rate) which we use to calculate the cost to enfranchise. It may sound innocuous, but the Cap rate has huge implications for the costs that leaseholders will pay.

While the Government and freeholders are slapping each other on the back over their freeholder’s pledge, many of the huge pension funds (which own vast ground rent portfolios) are very quietly spending a fortune trying to establish case law which aims to fix this cap rate massively in the freeholders’ favour.

If they are successful it will cost leaseholders who moved from doubling ground rents to RPI under this voluntary scheme thousands more to buy their freehold than it would do currently!

What are they looking to do?

Traditionally the Cap rate has been the least contentious element when agreeing the cost of a lease extension or freehold purchase. So much so, there is virtually no case law that can guide us. In the 17 years we have been in business 99% of our 10,000 settlements have seen us agree a Cap rate of between 6.5% and 7%.

However, this all changed about 18 months ago. Suddenly freeholders started to spend hundreds of thousands of pounds on legal fees and financial experts to set case law that says the Cap rate should be lower than 3%. And they’ve already seen some success!

In the most significant First tier Tribunal case from last year, known as ‘All Saints’, the freeholder achieved a very favourable decision from the judges which could have huge detrimental consequences for all leaseholders with onerous ground rents.

The valuer acting for the leaseholders wanted a 6% Cap rate, as he said this is the ‘industry norm’. The valuers acting for the freeholders originally proposed a Cap rate of 2.9% but altered it by the time it was heard to 3.09%. After a prolonged complex hearing the judges decided a Cap rate of 3.35%.

What does that mean for those who own leasehold houses with onerous ground rents?

Let’s look at a comparison of what this will mean in pounds and pence for owners of leasehold houses. The figures we use are for a house valued at £160,000 with a long lease.

The examples below show what effect a 3.35% cap rate would have on those people already caught in the leasehold house scandal.

If a house is worth £160,000 and the ground rent doubled every ten years until the fiftieth anniversary of the term, the cost of the lease extension would be:

Cost of freehold purchase with a Cap rate of 7%          = £18,000

Cost of freehold purchase with a Cap rate of 3.35%    = £92,000

If a house is worth £160,000 and the ground rent is linked to RPI reviewed every 10 years, the cost of the lease extension would be:

Cost of freehold purchase with a Cap rate of 7%          = £4,500

Cost of freehold purchase with a Cap rate of 3.35%    = £9,500

Hang on a second! If the freeholders set case law that stipulates a Cap rate of 3.35% then they would receive £74,000 more from anyone with a 10 year doubling ground rent and £5,000 more from anyone who had signed their lovely voluntary scheme which changed doubling ground rents to ones linked to RPI.

In short, to offset the lost revenue from onerous ground rents, freeholders intend to set onerous cap rates.

It is easy to see that a legal precedent that sets the fullsizeoutput_10f8Cap rate at 3.35% would be disastrous for leaseholders and the property market in general. It would make it impossible for any leaseholders to purchase their freehold or extend their lease.

It would have a huge impact on the returns the Help to Buy scheme would receive, as leasehold property prices would fall even lower.

It would be much harder for the government to prescribe the Cap rate element of the valuation method to make the process ‘cheaper, easier and more transparent’ for leaseholders (as they have promised, but so far failed, to do), as freeholders could argue material loss citing the Upper Tribunal case.

Why this is particularly unfair on leaseholders

Freeholders are prepared to spend a fortune on the best barristers and experts to set case law as the value of their freehold portfolio will rise exponentially if case law is set in their favour.

Leaseholders can never match the financial might of freeholders looking to argue their new precedent. I have no idea of the legal costs the freeholder spent in All Saints but they paid for one of the best barristers in the field and financial experts too who produced expert reports. The bundle of evidence they submitted to the Tribunal contained 2,200 pages of documents! The leaseholders had paid their valuer a few hundred pounds to argue their case. It is a battle as mismatched as David vs Goliath!

The freeholders are running very complex and unfeasible arguments to try to establish that Cap rates should be set at a much lower percentage. Due to historically low interest rates, they argue that returns on 25-year index-linked gilts (Government bonds) should be used as a benchmark for Cap rates, as well as RPI swap rates, LIBOR rates and yields from ground rent sales at auctions. If Cap rates are linked to the miniscule interest rate on gilts, the consequences will be disastrous for leaseholders.

Even if the judges involved in these cases truly understand these arguments fully, it is doubtful that they are qualified to make decisions based on this evidence. They are Property Tribunal judges after all, not financial experts regulated by the FCA. This is especially poignant when their decisions will adversely affect millions of leaseholders.

Who will be affected if a low Cap rate becomes case law?

fullsizeoutput_10fcObviously, all of those people who bought leasehold houses. For those who have ground rents that double every 10 years the cost to buy their freehold would be so eye-wateringly high as to make it pointless. In many cases they would be paying more than 50% of the actual value of their home simply to acquire the freehold title.

The scale of this travesty is much bigger. It would also have huge consequences for any leasehold property which has onerous ground rents or aggressive accelerators.

Then there are the many thousands of leaseholders that are hoodwinked into signing up for ‘informal’ lease extensions offered by their greedy freeholders every year. I get messages from concerned leaseholders every week who have been offered these ‘deals’, many of them from the very freeholders who have signed the Government pledge. These deals will leave them with homes that are unsellable.

As an example, we were in Tribunal last year against a freeholder who had got a leaseholder to sign up to one of their ‘informal’ deals a few years previously. Instead of extending their lease by an additional 90 years and reducing their ground rent to zero, they had opted for a ‘deal’ that extended their lease back up to 99 years and included a very onerous ground rent which doubled every ten years.

That leaseholder would not have needed to extend their lease for another 90 years if they had exercised their statutory right. Now however, some 15 years after paying for the lease extension they needed to extend again to prevent the lease falling below 80 years.

The freeholder then tried to argue a 3% Cap rate. This meant they wanted the leaseholder to pay £245,000 for a lease extension because of the terms of the informal deal they got the freeholder to sign previously. The property at the time was worth £390,000, so the lease extension would have cost a staggering 62% of the property’s value!

Clive Betts is correct to be concerned

It is deeply worrying that at the exact same time as signing a pointless pledge to treat leaseholders fairly, many freeholders are rushing to set case law which would see millions of leaseholders left with homes they could never sell and never afford to enfranchise.

It seems Mr Betts was right when he stated it would be “difficult for them to trust developers and freeholders”. In effect the freeholders are smiling to leaseholders faces, while sharpening long knives for their backs.

If this is allowed to go unchecked by Government, the consequences will be devastating for leaseholders who could never afford to fight these mighty freeholders in Tribunal. The Government must act immediately before a legal precedent is set. Failure to act would dwarf the misery wrought by the current leasehold scandal.

Caveat Emptor (Translation – It’s all your fault leaseholders!)

fullsizeoutput_f84Freeholders have a tried and tested phrase when leaseholders complain about the abuses they suffer. Caveat Emptor they glibly say. Buyer beware! The leaseholders either knew what they were buying or they didn’t obtain the correct legal and valuation advice before they signed the contract.

Freeholders bleat on about their human rights and the sanctity of contract law (funny, I didn’t know there was such a thing as the human right to exploit other people). The Government in turn are tip-toeing around them and their human rights as they try to change leasehold legislation in favour of the leaseholders. Unfortunately, freeholders understand far more about our arcane, archaic leasehold system and have so far managed to stay several steps ahead.

In fact Caveat Emptor is not a fitting argument. Cap rates have been uncontested since the leasehold legislation came into force. If you bought a leasehold house a few years ago, even with the best advice money can buy you could never have predicted that freeholders would be spending a fortune looking to change Cap rates.

That is not contract law. It is case law which can easily be set by whoever has the deepest pockets. Depressingly, that is the history of leasehold in this country.

If Mr Brokenshire’s amibition is really “to end those exploitative and unfair leasehold arrangements” He will need to take some quick action.  It is now time for the Government to forget window-dressing pointless pledges and step in to prevent further financial abuse and make it fairer for leaseholders once and for all.

It’s high time the leaseholder’s human rights became the focus.

1 Comment

  1. A depressing read. Its shameful how the government seems to be looking the other way whilst freeholders cement their greed in iron and stone.

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