Escalating Ground Rents – A ticking time bomb?

Ground rents are an annual payment to the landlord in return for the grant of a long lease, with the landlord ultimately having the property back at the expiry of the term.

Historically, ground rents have been low fixed rents with no review or reviews at infrequent periods during the term. However times have changed, and landlords now frequently include rent reviews in their leases. There are broadly four types of ground rent beyond the historic type which typically feature review periods of 10, 25 or 50 year reviews: (a) increasing the rent by a fixed amount each rent review period, (b) doubling the rent each rent review period, (c) rebasing against the Retail Prices Index at the end of each period and (d) rebasing the rent against a percentage of the capital value of the property of the end of each period.

You may have spotted recent press coverage about ground rent escalation clauses in residential leases, in particular new build flats and the adverse impact that they can have on resale values if the escalation is too quick. Some owners have found that their leasehold property has a hidden issue in a ground rent clause, which doubles the rent after a specific period or at set periods throughout the term of the lease.

For example, a ground rent of £250 per annum, which doubles every 10 years, would be £64,000 per annum after 80 years. This is a rate of increase over the first 30 years of 800%, which would clearly far outstrip any inflationary increase which these type of clauses purport to cover.

Rent review clauses are not uncommon or necessarily unreasonable but rent increases should to be checked carefully, in case the increases are unfair or unreasonable.

If a mortgage is involved the Council Mortgage Lenders handbook (which gives some of the terms on which the lending is based) provides as follows:

“We have no objection to a lease which contains provisions for a periodic increase of the ground rent provided that the amount of the increased ground rent is fixed or can be readily established and is reasonable.”

If the rate of increase is high or the dates of the stepped increases are too short there is an obligation on the borrower’s lawyer to report this to your lender, in order that they can take advice as to whether such a clause may materially affect the value of the property, as it follows that such an escalating ground rent clause could impact the marketability and value of a property.

An additional issue is where the owner or a future owner wishes to obtain a new, longer lease under the usual statutory procedure. The premium payable for the lease extension will take into account loss of ground rent under the old lease, as one of the statutory requirements for the new lease is that it will charge only a peppercorn ground rent. A high ground rent throughout a building will also have an effect on how much will be payable should the owner with the other owners in the building decide to exercise their right of Collective Enfranchisement (purchase of the freehold).

The amount of the ground rent at any given time can also be relevant to the statutory provisions affecting a lease. There are provisions (for example relating to assured tenancies) which apply to residential tenancies where long leases at a low rent are excluded. If the increase in the rent over the term of the lease brings the rent above a particular threshold set by the legislation, then the statutory provisions can have a different impact on a number of circumstances specific to each property.

The Government are aware of the issue and in the recent Housing White Paper touched on the subject of unreasonable ground rents, saying at paragraph 4.37.
“..ground rents with short review periods and the potential to increase significantly throughout the lease period may not be offering a fair deal. We are absolutely determined to address this. We will therefore consult on a range of measures to tackle all unfair and reasonable abuses of leasehold”.

The Secretary of State for Communities and Local Government has recently announced that he is planning to end the “unjustifiable and unfair” practice of developers selling new-build homes as leasehold under the Government’s help-to-buy equity loan scheme, where developers have doubled the rate of ground rent every decade.

Despite this announcement when and if the Government will take action remains to be seen, so in the meantime care should be taken to ascertain at the earliest opportunity when looking to purchase a leasehold property the current amount of ground rent and whether it is fixed or escalating. If the latter, consider the basis of increase. Once this information is to hand a decision can be made in conjunction with professional advisers whether it will impact on the future marketability and value of the property.

This article was written by Mark Rowden. For more information, please get in contact with Mark on +44 (0)1483 252642  or via mark.rowden@crsblaw.com.