Can commonhold ever be fit for purpose?

Martin Dawbney questions whether or not there could be a better alternative There has been considerable media coverage concerning the plight of certain homeowners facing high rents and unreasonable charges by residential landlords (see Tackling unfair leasehold practices). The housing White Paper published in February vowed to fix our “broken housing market” and the subsequent consultation paper issued in July sought views on specific issues. The consultation period has recently closed and the report is awaited with interest. There is now time to reflect on particular statements in the consultation paper that there is current abuse of the leasehold system and that commonhold may provide the solution. Is commonhold better than leasehold? The Commonhold and Leasehold Reform Act 2002 introduced commonhold tenure to England and Wales as a variant of freehold title and came into force in 2004 (primarily for flats). Its origins lie in strata or condominium title systems used elsewhere in the world to deal with the maintenance and repair of shared structures. The essence of commonhold is that each unit-holder owns the freehold of a flat, with the common parts vested in a commonhold association (a company in which the unit-holders are shareholders). A separate commonhold community statement sets out the principles of governance. Developers have found it difficult to persuade buyers to participate in a commonhold structure and only a handful of commonhold companies have been registered at Companies House. The underlying issue appears to be that the unit-holders do not typically want to participate in the running of the building and would rather leave management in the hands of a landlord. Even if commonhold is reformed (as proposed in the consultation paper) this will not overcome the fundamental issue of the inertia of the majority, leaving a small number of active individuals to manage the building to their own standards. It may work in a small block but breaks down in a larger development. Lenders too are mistrustful and can see scope for long-term disagreement between unit-holders as to the repairs needed to protect the overall integrity and value of the development. In contrast, a landlord is an independent party, able to mediate between opposing tenants and settle disputes regarding the standard, cost and frequency of repairs, for the benefit of the majority. Inevitably, each occupier will have different expectations, with some wishing to maintain a high standard of repair and decoration regardless of cost and others preferring to control the costs – in a commonhold scenario this can lead to potential stalemate and a shortfall in the amount required to carry out essential works, with the only way forward being to sue unit-holders for unpaid amounts. In the leasehold world, the landlord has the ultimate sanction of forfeiting the lease, thus unlocking the stalemate caused by a recalcitrant tenant (subject to the tenant’s right to apply to the court for relief). The experience of other countries shows that, where the element of third-party compulsion in multi-occupied buildings is removed (as in the commonhold structure), insurmountable problems emerge when a building nears the end of its design life. Those residents who cannot afford high repair costs refuse to contribute and those who are able to pay have to choose between subsidising the non-payers or allowing the building to fall into disrepair (and see the value of their own investment diminish). This dilemma is exacerbated where sinking funds have not been established or topped-up, and there are examples of this in Singapore, the US and the UAE. The landlord, on the other hand, has a long-term interest in the property, recovering possession when the lease expires. To motivate the landlord to repair the premises during the lease term a reasonable ground rent needs to be reserved, particularly as the lease will contain a quiet enjoyment covenant through which (under equitable principles applied by the court) the tenant could compel the landlord to carry out repairs where a management company has failed to do so. There is also a risk of dominant individuals in a commonhold-type joint ownership structure micro-managing or bullying owners who cannot be as actively involved in day-to-day management. In Australia, for example, this enabled owners of waterfront properties to remove the rights of land-facing apartment owners in the same development to use a waterfront boardwalk, without the latter agreeing to such change. What level of ground rent is appropriate? Much media coverage has focused on high ground rents; for example, those which double every 10 years. The criticism is justified, but in recent times these “10 doublers” are very rarely imposed in new leases as developers are heeding the accusations of unfairness. It has been suggested in the consultation paper that in future leases the rent may be a peppercorn. There is a need to strike a balance between the respective interests of the landlord and the tenant. To motivate the landlord to continue to oversee the development (which involves significant management time) and to provide assistance to a management company (taking over responsibility should that company fail to perform or go bust) a reasonable rent is appropriate. The quiet enjoyment covenant is further justification for a monetary rent. The ideal level of ground rent is set at a reasonable amount at the outset and then rises according to the rate of inflation (remaining the same in real terms) throughout the lease term. An initial 0.1% to 0.2% of capital value would seem appropriate, with periodic RPI reviews. This would not be burdensome for a tenant, when compared with service charge, council tax or stamp duty. Not a panacea Despite the consultation paper’s suggestion of exchanging leasehold tenure for a rejuvenated commonhold system, there is no reason to abandon the former, which has proved its worth over many centuries. By adopting fair practices (and developers should be incentivised to do so on a voluntary basis, with legislation following only if necessary) the burden of excessive ground rents can be addressed. The commonhold alternative, relying as it does on individual proactive participation, is not a panacea and the experience of other countries shows the long-term drawbacks of this alternative structure. Martin Dawbney is a real estate partner at Herbert Smith Freehills