UK: The Leasehold and Freehold Reform Bill – the “effective destruction of the leasehold system”?

Key Changes

The key changes envisaged by the Bill are:

• increasing the standard lease extension term for houses and flats to 990 years (up from 90 years for flats, and 50 years for houses);

• abolishing ground rents where a premium has been paid;

• making it less expensive to extend leases close to expiry (under 80 years left to run);

• giving all leaseholders – not just those who have owned their house or flat for 2 years – the chance to extend their leases, or purchase the freehold;

• increasing the “non-residential limit” to allow leaseholders in buildings containing 50% non-residential floorspace to buy their freehold; and

• imposing transparency over leaseholders’ service charges, as well as a redress scheme to allow leaseholders to challenge service charge, without being required to pay their landlord’s costs.

Status of the Bill

The Bill was introduced to the House of Commons on 27 November 2023, and was debated at its second reading on 11 December. It has now been passed to a Public Bill Committee, which will scrutinise the legislation line by line.

The Committee has issued a call for evidence, and will hold oral evidence sessions on 16 and 18 January 2024. Written evidence can be submitted until the Committee produces its report on 1 February 2024.

Ban on the sale of new leasehold houses

One of the flagship policies – a ban on the sale of new leasehold houses – did not appear in the Bill, but is expected to be added as a government supported amendment to it.

At the Bill’s second reading in parliament, Michael Gove also signalled it may later be amended to ban the sale of new leasehold flats too.  How that might be achieved is not clear, other than through reinvigoration of Commonhold, which is something that the draft Bill again has not tackled to the extent anticipated.

Abolition of ground rents for existing leases

Leaseholders of long leases are generally required to pay “ground rent” to the freeholder as a term of the lease. Unlike service charge, the freeholder is not required to provide anything in exchange.

Where the leaseholder pays a premium for their lease, ground rents have historically been minimal to reflect that premium. However, there is some concern – including from the Competition and Markets Authority - that ground rents have increased in recent years, and that high, and escalating ground rents, can make it difficult for leaseholders to sell or re-mortgage their properties.

The Leasehold Reform (Ground Rent Act) 2022 stopped freeholders from charging a financial ground rent on new leasehold properties, and the Leasehold and Freehold Reform Bill proposes to do the same for existing (pre-2022) leases (though this provision is yet to appear in the draft legislation).

This raises concerns for institutional investors, such as pension funds, who face having historically  secure, long term income streams stopped. The government estimates that banning ground rents altogether would lead to losses of £5.1 billion for freeholders over a 10 year period, with asset values reducing by £27.3 billion over the same period.

Following the introduction of the Bill, the government launched a consultation, which is open until 17 January 2024, and suggests 5 possible ways to deal with existing ground rents:

1. capping ground rent at zero;

This is the government’s current proposal, though they acknowledge the risk of institutional investors leaving the market, and have flagged the risk that this may also leave freeholders unable to meet remediation costs from accumulated ground rents.

2. capping ground rent at an absolute maximum value (around £250 per annum);

The government’s full economic assessment anticipates this would amount to a £2.3 billion loss to freeholders (and saving to leaseholders) and a £14.6 billion reduction in asset values over a 10 year period, but it would provide certainty and a consistent ground rent income. 

3. capping ground rent at a percentage of the property value (0.1%)

The government anticipates this would lead to anticipated losses of £2.3 billion for freeholders, and a £14.7 billion reduction in asset values over a 10 year period.

It also creates potential difficulties and disputes over the property valuation – not least the cost of such valuations, which the government envisages would be borne by freeholders.

4. Capping ground rent at the original amount it was when the lease was granted

The government argues that this would reflect the original agreement between the parties, but avoids the downsides of rent escalation. However, with a long lease it may be difficult to establish what the original ground rent was, and this takes no account of changes in the value of money over time.

The government anticipates this would cause a £0.6 billion loss to freeholders, and £7 billion reduction in asset values over a 10 year period.

5. Freezing ground rents at current levels

Freezing ground rent at current levels would mean there could be no further increases. The government noted that this is a simple mechanism which “respects” the original contract between landlord and tenant, and may have less of an impact on freeholders’ business models (though the government still anticipates a loss of £0.4 billion to freeholders, and £4.2 billion reduction in asset values over an 11 year period).

Leases of under 21 years, or where no premium was paid, are expected to be exempt from any cap on ground rent.

Compensation

As the government’s economic assessment demonstrates, any of these options would represent a huge cost to freeholders and institutional investors, and undermine legitimate investments and anticipated income streams.

The government has indicated that it “would not expect to compensate freeholders for lost revenue, nor do we expect freeholder would be able to capitalise this lost income stream through other means” (i.e. service charge).

However, this is a key area of concern for freeholders and institutional investors, and is one of the areas of focus in the consultation, which may impact on the final content of the Bill.  The sums in question might prompt some stakeholders to consider challenging the proposed constraints on ground rents in existing leases, including challenges under Human Rights law.

Any future for commonhold?

While it does not feature in the Bill, commonhold has long been considered the future for leasehold reform, though it is a sharp departure from the system that has been prevalent in the UK for centuries.

In July 2020, the Law Commission published a report titled “reinvigorating commonhold: the alternative to leasehold ownership”. In that report, they made a series of recommendations aiming not just to make commonhold a workable alternative to residential leasehold ownership but “the preferred alternative”.

Commonhold was introduced in 2004 by the Commonhold and Leasehold Reform Act 2002, and allows for freehold ownership in blocks of flats, with shared ownership and management of common areas and services. Commonhold and similar systems are widely used in Australia and America, but there has been minimal take up in the UK.

At the bill’s second reading in Parliament, Michael Gove agreed that “commonhold is the ideal form of tenure”, but that the Bill would not impose it as standard. The Shadow Housing Minister, Angela Rayner, indicated that a Labour government would make wider reforms, making commonhold the “default tenure” for all new properties.

As the Bill still appears to be a subject of considerable debate, with further amendments expected, watch this space to see if commonhold makes a come-back.

What does this mean for leasehold?

The provisions of the Bill are still the subject of consultations and parliamentary scrutiny and debate, and seem likely to evolve.

The expansion of leaseholders’ rights will be widely welcomed, but whichever route is chosen to reduce ground rents will profoundly change the landscape for institutional investors, and the residential property market itself.

Authored by Tim Reid and Lucy Redman.