The proposed ground rent cap and its impact

It is a well-established view that reform of ground rents is long overdue.

Under the draft Commonhold and Leasehold Reform Bill, it is proposed that most existing long residential ground rents would be capped at £250 a year and then reduced to a peppercorn after 40 years.

That sits within a wider programme of change following the Leasehold and Freehold Reform Act (LAFRA) and it reflects a broader attempt to make leasehold less punitive for consumers while preparing the ground for wider use of commonhold.

The scale of the issue explains why the government feels compelled to act: a House of Commons research paper states that there are around 3.8 million leasehold homes in England and Wales with a ground rent obligation, with around 770,000 to 900,000 leaseholders paying more than £250 a year.

ALEP, which represents solicitors and valuers working within leasehold reform, conducted its own research. 81.8% of its membership agreed that ground rents can have a negative or undesirable impact on the sale of leasehold properties and 70% said some ground rents cause problems in agreeing a mortgage, while selling a property with a high ground rent can also be an issue.

Impact on leaseholders

The government also argues, in its policy statement Addressing unregulated and unaffordable ground rent, that a future move to a peppercorn rent would remove the two-tier position between older leases and newer leases already caught by the Leasehold Reform (Ground Rent) Act 2022 and should support the longer-term move towards commonhold.

The difficulty is that not all leaseholders will experience reform in the same way. Some already pay a peppercorn/very low rent and will see little immediate benefit.

Others may reasonably feel aggrieved if they have already paid significant sums to extend a lease or acquire a freehold based on current rules, only to see neighbours benefit if a cap is introduced.

That raises questions of fairness between different groups of leaseholders which could affect harmonious relationships which is a crucial factor for a share of freehold or commonhold arrangement to succeed

Additionally, where the real problem has been poor advice, opaque drafting or inadequate explanation at the point of purchase, a cap on ground rents addresses the symptom rather than the cause.

ALEP’s survey found that 43.2% identified problems arising because the full ground rent terms had not been made clear when the property was bought, while 31.8% said leaseholders often do not understand how much the ground rent will increase. Clearly reform should be accompanied by better consumer understanding and better professional advice, not treated as a substitute for them.

Impact on freeholders

There is no avoiding the fact that the proposal is generally negative for freeholders. Ground rent portfolios are valued relative to the income they produce and the government accepts that the policy will inevitably transfer this value to the benefit of leaseholders.

That is presumably why the government rejected an immediate peppercorn cap for existing leases and instead opted for a £250 cap moving to peppercorn after 40 years – but invariably freeholders will argue that this is not enough.

Furthermore, it would be wrong to make assumptions about freeholders: they are not a single class of wealthy private individuals but include pension funds, charities and local authorities all of which will inevitably see reduced dividends.

It is important for freeholders to be prepared. Portfolios should be reviewed to identify leases with rents above or approaching the proposed cap, especially where escalation clauses are onerous. The likely impact on valuation, income forecasting and any financing arrangements should be reviewed now, prior to the proposals becoming law.

Freeholders should also pay close attention to the detail of implementation, exemptions and any secondary legislation, because the operational impact may turn on drafting rather than principle. It is notable that the government’s impact assessment expects the cap to require further legislation, guidance and an enforcement framework before implementation in 2028.

Impact on the market

From a market perspective, the benefit is that the cap should address the ongoing onerous ground rent debate, providing comfort for lenders and leaseholders.

On the other hand, that redistribution does not occur in a vacuum. If asset values are reduced retrospectively, investors will look more carefully at the security of future residential income streams. Stability and predictability are of upmost importance.

There is also a risk of creating fresh distortions. Some leaseholders will gain immediately, while those who already regularised their position under the old rules may feel left behind.

Some share of freehold arrangements may also face internal tensions if earlier decisions were taken in reliance on continuing ground rent income. Reform may therefore remove one unfairness while creating new areas of resentment.

Unintended consequences

One possible unintended consequence is pressure on the economics of future housing schemes. For example, it has been argued that ground rent income provides some compensation for developers with s106 obligations to provide affordable housing.

If that is the case, and the government continues to increase Section 106 obligations on residential development while removing this long-term income stream, a rebalance will be necessary elsewhere – potentially in land values, pricing structures or reduced headroom for affordable housing which will inevitably have wide-ranging consequences

There are practical obstacles too. The proposal still has to move through scrutiny, legislation, secondary rules and implementation. The anticipated start date of 2028 allows time for further argument over exemptions, enforcement, treatment of intermediate leases and interaction with enfranchisement.

There will inevitably be a Human Rights challenge – as we are already seeing in the case of the LAFRA. This has already led to immense delays in implementation leading to greater uncertainty in the market.

Conclusion

The sunset nature of the ground rent proposals recognises the expected backlash and challenges to the changes and seeks to reduce the impact.

While the proposed ground rent cap addresses a genuine problem and will benefit many leaseholders, the success of the reform cannot be judged solely by whether it produces an appealing headline or a quick political dividend and implementation will be the true test.

Shabnam Ali-Khan is a Partner at Russell-Cooke and a member of ALEP (Association of Leasehold Enfranchisement Practitioners).