The end of residential ground rents
Headlined as one of the ‘most significant changes to property law in a generation’, the Act restricts ground rents on newly created long residential leases. Ground rents have been replaced by a token one peppercorn per year – effectively zero in monetary value.
By restricting ground rent, the government is aiming to make leasehold ownership more affordable. It also forms part of a wider reform package, with future legislation set to be brought forward to address factors such as lease extensions and marriage value.
The Act will have a financial and operational impact on the UK living sector that has utilised ground rents for over 40 years. It poses particular challenges to the structuring of mixed-use residential and commercial developments, removing a potential revenue stream for freeholders and opportunity for investors.
So, months on from the Bill’s first reading in the House of Commons in September 2021, how has the UK’s living sector prepared for the Act to take effect?
Ahead of the new legislation coming into force, the residential market was already evolving, with a number of developers reviewing their approach to ground rents.
It has quickly become the norm for most new residential apartment leases to be granted to owner occupiers without ground rent following the lead taken by UK housebuilders to abolish ground rents altogether prior to the legislation coming into force.
Although the pending legislation may have been a driver for some in the residential sector to review their approach to ground rents, many larger housebuilders and developers were already facing significant pressure from the public and media to act.
What this does mean, however, is that some smaller developers may have found themselves in a position where they have had to act quickly to ensure they are not in contravention of the Act.
It is this part of the market that may also be potentially more exposed to the financial implications of abolishing ground rents – operating on tighter margins or without the operational and financial resources to manage the transition.
In this situation, it is critical that developers firstly ensure that their lease structures are not in breach of the Act, as this could result in fines of up to £30,000. Careful consideration must also be given to the commercial viability of sites, with a focus on how the removal of ground rents could impact their freehold interests and attractiveness to investors.
The long-term effects of ground rent abolition are yet to be realised, but it is likely that we’ll see a re-evaluation of land purchase values downwards and/or unit prices upwards to help recoup the lost income that was previously factored into development appraisals.
Backtracking on retirement living
Retirement living was initially identified as being exempt from the Bill. That’s now changed.
Following the government switching its position, retirement properties – for residents 55 and over – will be subject to new legislation. This will come into force at a later date of 1 April 2023.
When compared to other parts of the UK’s living sector, the Act could pose specific challenges for retirement properties as ground rents can often play a greater role in the funding structure of a development and its facilities than in other living schemes.
Retirement housing developers must, therefore, take into consideration the loss of a valuable and saleable income stream from completed developments, and how this affects their initial viability and future operation.
Some developers may think an increased service charge might be the answer to cover any shortfall, however, this market has been dogged by negative press around Deferred Management Fees and Event Fees and this could be the next challenge should residents feel they are being unfairly charged. The sensitivity around increasing service charges is one that straddles the wider living sector.
It is crucial that retirement living developers begin to prepare for the legislative change now.
Where viable, this could involve taking a similar approach to some of the residential developers and housebuilders that had already stopped charging ground rents on new homes – adapting their financial and operating models before being legally obliged to.
Dealing with this change in advance can allow retirement living developers to ensure they are prepared and in the best position possible for when the Act comes into force next year.
A hurdle for mixed-use developments
Another area that could face disruption as a result of the Act is mixed-use developments.
Removing ground rent creates a situation where the only regular income stream for a scheme is commercial rents. This may influence the relationships between landlords, commercial tenants and residential leaseholders, with uncertainty over who is the best long-term owner of the freehold, considering the different interests and financial obligations.
Although an increasingly common option for pure residential developments, transferring the freehold of a mixed-use building to a residents’ management company is complex due to factors like maintenance, service charge recovery and the changing regulatory environment.
Thought must be given to how well-equipped a residents’ management company will be to oversee a mixed-use development. All parties must work together to identify who is best-equipped to take on the role of freeholder and manage any long leasehold interests.
While the effects of the Act will be felt more acutely in some areas of the living sector than others, the legislation will have a lasting impact on how it operates. We’re already seeing this happen, especially when it comes to large-scale residential development.
Those in the sector must remember that they do not face these changes alone. Seeking professional expertise is vital to remaining legally compliant and commercially successful.
This article was first published in EG on 25 June 2022. It has been updated following the Leasehold Reform (Ground Rent) Act 2022 coming into force.
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