Gregor Kleinknecht discusses leasehold agreements in Discover Germany

  • October 09, 2017
  • By Gregor Kleinknecht, Partner

New Home Buyers: Beware the Leasehold Trap

The government recently conducted a consultation on Tackling unfair practices in the leasehold market which looked at a range of measures aimed at preventing unfair practices and abuses of leasehold agreements in the context of new residential home sales.  So what is the issue?

The issue arises from the distinction under English law between freehold and leasehold interests in land:  put simply, freehold ownership of land is the outright and absolute ownership of land and property for an unlimited period of time.  By contrast, a leasehold interest is a long-term but time limited right to occupy and use a property for the term of the lease but the freehold remains in the ownership of the landlord and the property will eventually revert back to the landlord when the term of the lease has come to an end.  Also, there will be a formal lease between the freeholder and the leaseholder and this is where the problem resides: the lease can impose onerous obligations and restrictions on the leaseholder.  In particular, in financial terms, the lease can require the tenant to pay ground rents and these ground rents cannot only be high to start off with but are on top then often linked to an escalation clause which sees them increase significantly over time.  Fees may also be payable for a permission to make alterations to the property, or the freeholder may seek to sell the freehold interest to the leaseholder for a significant additional payment.

In practice, this has two principal consequences: first, the lease gives rise to increasingly burdensome long-term financial obligations which the leaseholder may not have properly taken into consideration when he acquired his interest in the property; and, secondly, in extreme cases, it can make it all but impossible to sell or re-mortgage the property and can catch the leaseholder in a negative equity trap.

This is not a theoretical problem and there has rightly been considerable media focus on the issue.  The percentage of residential sales that were leasehold has been growing at a steady pace, in particular, in the north of England.  Land Registry figures show that leasehold made up 43 per cent of all new-built registrations in England and Wales in 2015, compared to just 22 per cent back in 1996.  There can be legitimate reasons for selling a property as leasehold, for example, in the case of flats, where it helps with property management, but leasehold arrangements are more difficult to justify where the property is a house.  In any event, even where a leasehold may be appropriate in principle, this does not of course justify unreasonable contract terms exploiting home buyers.  So what to do about it?

In its consultation, the government sought views as to whether it would be appropriate to ban the sale of new-built leasehold houses altogether.  Also, historically, ground rents were often set at a nominal level (a ‘peppercorn’) and the government sought views on whether the starting value and increase in ground rents on all new residential leases for flats with a term over 21 years should be restricted to the traditional ‘peppercorn’.  Finally, the government proposed to limit landlords’ ability to seek mandatory possession orders for ground rent arrears – which put the leaseholder at risk of losing his interest in the property altogether.

Finding themselves in the headlines for all the wrong reasons, some home builders are belatedly seeking to mend their ways and have launched schemes to help distressed leasehold buyers.  The measures proposed by the government are nevertheless sensible to put an end to such practices.  They may have the effect of increasing the initial purchase price of many residential homes but that may well be a price worth paying for the financial certainty which home buyers will gain in return.  In the meantime, the best advice for anybody contemplating the purchase of a leasehold property must be to obtain proper advice and to make sure that they understand the implications of the contracts they are asked to sign.

Gregor Kleinknecht, Partner 

This article was originally published in Discover Germany, Issue 55, October 2017 and can be accessed here

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