Whenever I hear someone bemoan the fact that their home has become ‘worthless’, I know someone else is about to make a killing.
Properties do sometimes become genuinely worthless — if they sit on a crumbling clifftop, for example. But more often than not a property that has become blighted is not valueless at all, but merely harder to sell. There’s still value in it for anyone prepared to look beyond the blight and realise it.
So it is for leasehold houses with doubling ground rents. The scandal that has erupted in the past few months is likely to be followed by a second scandal, in which homeowners with hard-to-sell properties are persuaded to sell them at fire-sale prices to speculators who then sell them on at a big mark-up.
It’s never easy to see where the next financial scandal is going to hit. A few years ago the big problem with leasehold properties was soaring service charges. Few leaseholders bothered about ground rent; many were barely aware of it.
Ground rent arises because when you buy a leasehold property you are not really buying a physical asset at all: you are buying a rental contract of up to 999 years, with most of the rent levied up-front in the purchase price. But there’s usually an annual ground rent, too, and often it amounts to so little (a ‘peppercorn’) that the freeholder doesn’t bother to collect it. In other cases the ground rent is £100 to £300 a year, and some leases have provision for it to rise over time, in line with inflation.
Trouble is, if you’re writing a lease for a millennium, it’s difficult to link ground rent to any official measure of inflation: slim chance that in the year 3016 there will still be an Office for National Statistics publishing a monthly Retail Price Index. So leases resort instead to clauses stating that, every so often, the ground rent simply doubles.
My wife owns a small flat with a doubling ground rent, but I did the sums when she bought it and decided it was not onerous. The £300 rent will double every 20 years for the first 100 years of the lease, and remain flat thereafter. In 100 years’ time, therefore, the rent will be £9,600, which sounds a lot but is highly likely to have been eaten by inflation. A 20-year doubling ground rent will retain its real value if inflation averages 3.5 per cent. At the Bank of England’s target of 2 per cent inflation, our £300-a-year ground rent will hit a peak real value of £1,325 before declining. That would still be less than the service charge on most London flats.
But some developers slipped a nasty trick into new leases. Instead of doubling every 20 years, they made them double every ten years. The difference is colossal. After 100 years, a £300-a-year ground rent reaches £307,200. At 2 per cent inflation, that would be the equivalent of £42,000 today. Developers also started building leasehold houses, either holding on to the freehold to enjoy a return from rising ground rent, or selling it to an income investor.
Little wonder there’s such anger over these leases. In July, Communities Secretary Sajid Javid responded by announcing a ban on the sale of houses on leaseholds (except where the developer had itself bought the land on a lease, such as from the Crown Estate). New leasehold properties will have to have fixed peppercorn ground rents.
But where does that leave people who have already bought leaseholds on ten-year doubling rents? Sensing the reputational damage, one developer, Taylor Wimpey, in April set aside £130 million to compensate buyers of leasehold houses. Countryside Properties, too, has said it will buy back some freeholds.
But what of the rest? Unsurprisingly, owners with doubling rents find their homes have been blighted. Many mortgage-lenders refuse to lend against them, making them very difficult to sell.
But does it really mean that the properties have become worthless? No. Anyone who has owned a leasehold for two years has the right to buy the freehold, or ‘enfranchise’. That might be beyond the means of leaseholders quoted prices of £30,000 or more. But they shouldn’t despair. First, there is a formula recognised in law to work out how much a leaseholder should pay for a freehold. Those who have been quoted exaggerated sums will find the price reduced once they employ a surveyor with knowledge in this field. And if you still can’t afford the freehold? The value of your home will not drop to zero. If it would be worth £250,000 as a freehold and the cost of buying the freehold is £20,000, its value should not drop below £230,000.
Someone will already have worked out that there are profits to be made from buying leaseholds from overly pessimistic owners at distressed prices, holding them for a couple of years and then enfranchising. I don’t think we have heard the end of the scandal of leasehold houses yet. Rather, we are about to see one set of opportunists replaced with another.