Are freehold ground rents a good investment?

by Readers Question

17:38 PM, 31st July 2013
About 7 years ago

Are freehold ground rents a good investment?

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Are freehold ground rents a good investment?

I have just started investing in property.Are Freehold Ground Rent Investments a good investment?

Living overseas, I have been unable to get a U.K. mortgage so I have had to pay cash for my first property.

I have a good rental yield of 10.1%, but obviously no leverage for now. I am arranging more business commitments in U.K. to eventually remedy the mortgage problem.

My question is this:

I have been looking at, but not buying, Freehold Ground Investments which I often see available:

For example, £3,000 buys the freehold ground rent for 125 year (or less) leases paying £300 per year (S5(b) Notices have been served under the Landlord & Tenant Act 1987). Not a lot of money each year, but still 10% yield.

My question is this. Would a portfolio of these types of investments qualify for a loan for reinvestment into buy to lets?

The 10% yield from the Freehold Ground Investments could be used to pay off this initial loan.

For example, £400,000 invested in freehold ground rents should produce £40,000 per year.

A 75% LTV would be £300,000 which you could pay back using the ground rent income of £40.000 pounds per year.

Use the £300.000 as £30,000 75% buy to let (for example) deposits on 10 houses (or go up north and buy 8 for cash, then re-mortgage, or whatever the permutation gives most yield???).

The 10 properties, if bought wisely could be refurbished re-valued as usual to earn the required yield. The debt would be paid by the freehold ground rent investments.

I know you could just use the initial £400,000 pounds direct into property but the freehold ground rents look to be low maintenance no void investments. Their value rises as time passes and looking (as I am) to leave the property portfolio for future generations, so long as the yields are good, the investment vehicle (within the property portfolio) is just a money generating wealth creating exercise, and one day, someone will be grateful for present day foresight.

I would appreciate comments regards Freehold Ground Investments and the possibility to obtain loans using them for the purchase of properties.

Thanks

Christopher Farrell



Comments

Mark Alexander

17:46 PM, 31st July 2013
About 7 years ago

Hi Christopher

I have never come across a lender which has offered finance on ground rents. All the investors I know who own them buy for cash.

10% seems to be a very high yield, I believe 5% is closer to the norm these days.

As you say, they are an excellent alternative to holding large sums of cash as yields are better than returns from banks, they are a safe investment, they are relatively easy to sell (but time consuming), you can also make money off the back of selling lease extensions, there are plenty of companies who will deal with the management for you, rents rise.

The ONLY reason I don't have a huge portfolio of them personally is the lack ability to gear up.
.

Christopher Farrell

18:59 PM, 31st July 2013
About 7 years ago

Hi Mark,

Thanks for the comments.

The mentioned 10% yields are from some ground rents I have seen for sale. If they had associated problems, hence the high yield, I don't know.

It is a shame, is as you say, there is no gearing available via loans.

It is still something I would be interested in, in principle, for spare cash, if they are easy to sell on...

...although that said, being new to property, I would not see me having much of that spare for a while (apart from cash funds required for emergencies).

I would like to hear from anyone who has had experience with ground rent investing, pros and cons etc.

Mark Alexander

19:04 PM, 31st July 2013
About 7 years ago

Reply to the comment left by "Christopher Farrell" at "31/07/2013 - 18:59":

Check out these Member Profiles and the articles they've commented on 🙂

Annette Stone >>> http://www.property118.com/member/?id=384

Lauren Wadey >>> http://www.property118.com/member/?id=389

Roger Hardwick >>> http://www.property118.com/member/?id=449
.

Anon

0:56 AM, 2nd August 2013
About 7 years ago

Reply to the comment left by "Mark Alexander" at "31/07/2013 - 17:46":

I would strongly suggest people stay away from Ground Rents as an investment.

Yes, buy the Freehold for any property you own.

But frankly chasing a £50 ground rent is a pain. You have to insure the property and then keep chasing the leaseholder to pay up. You can't cancel the insurance as it opens you up to liability.

In the old days, if the leasehold did not pay, then you could go to their mortgage company and they would cough up and bills would be paid.

Now the laws treat leaseholders like consumers..... It is a lot of paperwork / admin / procedure for little money and a lot of aggravation. If suggest people spend time reading some of the LVT tribunal cases, you could end up loosing your shirt.

You might hit the jackpot, if a leaseholder wants to extend their lease, but to be honest, if they had wanted to do that, they would have bought the Freehold before you. Plus, there is a lot of horse trading in terms of valuations of leases and extensions....

Puzzler

15:10 PM, 2nd August 2013
About 7 years ago

1) if you live overseas you may not be able to get lending anyway as you have found for mortgages (why would freehold be different? in any case others have said that lending is not readily available for freeholds)

2) as the freeholder you are responsible for the fabric of the building and maintenance of communal areas (usually via a management company). The leaseholders pay for this but you have to arrange it and supervise the company whose client you are. So it's not just easy money.

The returns are not great until you get an extension which can be many years and there is no guarantee that the law will not change to favour leaseholders further as it did in 1993 giving the right to lease extensions.

I have one plus half the flats in a converted period property due to inheritance (the other flats sold off before I inherited) and do not foresee making much from the freehold for a long time. If leaseholders exercise their statutory right to extension before the lease diminishes below 80 years then you will make next to nothing. If the leases are short then that will be factored in to the sale price.

Puzzler

15:35 PM, 2nd August 2013
About 7 years ago

3) ground rents are set at the beginning of a lease and may or may not have a provision for periodic increase (e.g. every 25 or 30 years). Either way inflation will erode the yield from the start. If a lease is extended under the statutory process the ground rent will be nil (peppercorn). There are some good websites including http://www.lease-advice.org with the details.

Annette Stone

18:18 PM, 2nd August 2013
About 7 years ago

Interesting comments from everyone as usual. I bought my first ground rent in the early 1970s paying 4 x ground rent and have been investing ever since. The market has changed enormously but there is still a lot of money to be made. This is not, I repeat, not a business for amateurs and if you are buying ground rents which have management devolved as a freeholder's responsibility you have obligations which you either need to be able to deal with yourself or have good management in place.

My firm manage on behalf of a wide range of freeholder, including my own portfolio as well as for private landlords of either small or large portfolios and for lessees who have bought their freehold. . My speciality is the investment side of things adn I I continue to buy both on behalf of myself and also for investors. I also have a professional practise which deals with lease extensions for a number of investors

As far as yields are concerned for good stuff you cannot achieve 10% and as Mark says 5% is more likely. It is a fact that when interest rates are low ground rent returns offer better value but then the prices go up achieving 20 or 25 x ground rent at auction is not lunusual, depending on whether there is the possibility of a management income or if it is straight ground rent.

It is mostly small things that come to market now as many large blocks are bought by their lessees and most new build blocks are bought by ground rent specialists during the development process and the legislation regarding offering lessees the opportunity to buy is circumvented by the "investor" putting money into the development and taking the freehold as his "return"

As far as lease extensions are concerned it is true that you can make a great deal of money on a flat if the lease is short and the ground rent is one which increases at 25 or 33 year intervals. There is a formula for working out the value of a lease extension and even if this comes to Tribunal as a result of a dispute a fair price is set. I deal with many lease extensions each year and always achieve a fair deal for both lessee and client freeholder. There is no question of a freeholder not receiving the full value of his investment; this is a misconception.

If lessees seek to extend their leases when there is more than 80 years left then, again the formula is pretty much set. There is still a very good profit to be achieved and, particularly on modern leases where you can have a starting ground rent of £300 doubling every 25 years (or even every 10 years as I have seen) provides a very good profit when you take the multiples into account.

Of course, all the profit depends on how long you have had the ground rent and how much you paid for it and it is impossible to make generalisations as each case is different.

There is another possibility of profit and this is if you are able to establish any development potential. Recently I worked on getting planning permission to put three flats in a basement area which will give the freeholder an 18% rental return on his building costs.

My advice to the questioner is that if you are considering buying something ether privately or at auction make sure you see ALL the leases and check there are no onerous clauses such as the freeholder having to advance funds for major works. Make sure none of the leases have been extended and if you buy at Auction make sure that the lessees have not exercised their rights

Finally, the comments about cash flow are very important. It is not possible to either fund ground rent purchases or use them as security for loans. I have seen a portfolio worth £8m dismissed as valueless by one of the big four Banks. That having been aid, ground rents work are wonderful as a pension and if you look at ISAs paying around 2% per annum you can make your own comparisons

I hope this is useful

Hope this is helpful. I

Christopher Farrell

18:58 PM, 2nd August 2013
About 7 years ago

Hi Again,

I have just posted and now I see Annette's post.

Thank you, very informative...
...I know who I will be contacting if I decide.

initially I was more interested in them as something for future generations. A few free properties for my grand/great grandchildren (as leases expire) appealed to me. This probably wouldn't be so...

...I would hate to have 8 million in them and the bank class them as worthless.

Perhaps for now better to water the acorn than to value the tree.

Christopher Farrell

18:58 PM, 2nd August 2013
About 7 years ago

Hi all,

Thanks for your comments.

I was looking at ground rents for portfolio diversification. I appreciate it may be hard to want to invest in something which is rather abstract in nature.

I wasn’t, when I posted, aware if loans were available or not for ground rent purchases, hence the post. I was also ignorant of legislation.

I do know that there are many heavyweights (institutional investors) investing very large amounts of money in ground rent portfolios, there are even Ground Rent income funds out there (of no interest to me, I manage my own funds).

In all events, I wouldn’t need loans for ground rent purchases, just to use them as collateral for future loans. Mark has answered this in the first post. As he mentioned, the only reason he doesn’t have a huge portfolio of them personally is the lack of ability to gear up.

If loans were available using a ground rent portfolio as collateral then gearing would apply. I do appreciate there are management issues for them (as there is for property although perhaps more intense on larger ground rent portfolios).

In my ignorance, they initially appealed because of relative stability (no voids, immune to rising or falling property prices, interest rates (which will come eventually) etc. and although you cannot do much with them, 10% (compounded) yields did appeal, and as mentioned, I would probably have no need to sell them (or any property I buy).

I will probably not invest in them, so now I am just acting as Devils Advocate…

I live overseas in Spain, but I am British, and have dual residency, I just don’t have a credit rating because I haven’t worked for many years in U.K., but I will be moving back there on a more permanent basis within a year and property investment (I have family in U.K. already involved) has always appealed to me, and Spain IS NOT the right place for property investment at the moment. With 26%+ unemployment and almost non-existent Govt. help, the housing market (for investment purposes) is to put it mildly rather gloomy. I have friends who have lost almost everything with property portfolios. Rents unpaid, no LHA, unpaid mortgages, repossession difficulties, and properties repossessed etc., a nightmare.

That said, now is the time to get up to 50% discounts on your holiday home if you want one, as I am sure the same can be said about Greece or Portugal.

At this point, I will probably shelve the ground Rent Portfolio idea.

I would have liked to hear something positive about them (from someone who perhaps has invested in them).

Property investing is all about gearing in my opinion. If everyone had to pay cash for property there would be no appeal. The original question was to see if gearing was applicable to Ground rent portfolios and if anyone out there had invested in them, gearing or not.

sam

5:50 AM, 3rd August 2013
About 7 years ago

Does anybody know what rights are accorded the leaseholder and freeholder when a lease expires ?

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