Leasehold reform: put cost at the heart of the debate

There is no denying the real strength of feeling towards improving the leasehold system. But the narrative is too focused on the power balance between freeholder and leaseholder, and not the issue that has created it – the unnecessary costs associated with purchasing a freehold or extending a lease and the spiralling price of a lease if matters are left too long.  If the government is to truly reform the leasehold market, it must tackle the issues of transparency and cost. But this should not be done at the expense of the system itself. For it is not broken. What has gone wrong is that the Leasehold Reform Act 1967 (the 1967 Act) has been liberalised to a point where exploitation of the system is easy and frequent.  The birth of leasehold reform The 1967 Act was never designed to be as wide-reaching as the Leasehold Reform, Housing and Urban Development Act 1993 (the 1993 Act) is today. The initial Act was passed because of the plight of Welsh miners, whose 99-year leases were due to expire.    Restricted to low-value owner-occupier houses, not flats, which were the main residences of the leaseholders, the 1967 Act was about protecting the status of these comparatively low-income workers as owner-occupiers. It recognised that the leaseholder had originally paid for the bricks and mortar, which were not expected to last more than 99 years. Since the bricks and mortar were still there, the 1967 Act allowed the leasehold to retain the value of this part of the freehold house and only pay for the land. In South Wales the price for the freehold was about 30% of the freehold value of the house.    Significance of 1993 In 1993 the game began to change. The introduction of the 1993 Act created the right of owner-occupiers to extend their leases by 90 years. It also removed the low-value test for houses, restricting these rights to only the main residence of the leaseholder. However, the passing of the Commonhold and Leasehold Reform Act 2002 (the 2002 Act) liberalised the system, opening the floodgates to the leasehold quagmire we are experiencing today. Significantly, this legislation brought high-value houses and flats, which could be owned by any entity, into the equation. As far as owner-occupiers were concerned, this was fair enough, but from 2002 one set of investors (the buyers of leasehold properties) was given preference over another set of investors (the original freeholders). The 1993 Act was perceived by owner-occupiers as too unfair because it discriminated between house lessees and “low-value” flat lessees. The latter had to pay (then) not less than 50% of the marriage value to the freeholder for their 90-year lease extension. The former did not. This attracted a new breed of investors into the market who saw a disproportionate return – a 50% share of marriage value could be significantly greater than the term and reversion value alone.  By way of an example, a house worth £150,000 freehold in Birmingham held on a lease with 15 years unexpired at £6 pa, but sublet to a non-qualifying tenant, would have a term and reversion value of about £66,500. However, the premium under the 1967 Act would only be around £25,000. The investor who bought this lease for £50,000 would make a profit of £75,000, but the investor who owned the freehold would lose £41,500. If it was a flat, the premium would be £66,500, plus half the marriage value. The potential for early profit increased when the 2002 Act was enacted as more demand was created by a change in the lending policy of mortgagees beginning to demand the existence of longer and longer leases before they would lend and the increasing importance of buy-to-rent investors. Freeholders of flats and higher-value houses did not suffer any loss from having to grant lease extensions (or sales of freeholds), because of their share of marriage value and the fact that capital gains could be rolled over. Most good landlords were content to see the achievement of early profits arising out of the system. However, tenants not only have to pay a premium to achieve their right to enfranchisement, they also have to pay most of their landlord’s costs. The total cost to the tenants under schedule 12 of Part II of the 2002 Act is made up of the reduction in the value of the landlord’s interest (being the loss of ground rent income, reduced to a peppercorn, and the loss of his reversion), 50% of the marriage value, two sets of solicitors and valuers’ fees and SDLT. Therein lies the heart of today’s problem, especially where the costs can exceed the premium. Not all properties are of high value.  Unfair lease terms, such as doubling ground rents every 10 years, or unreasonable restrictions, must also be tackled – low-cost conveyancing has often left tenants badly advised. But pension funds and charities have purchased many of these investments. The same injustice of giving preference to one set of investors over another must be avoided. Reform: a balancing act? The scales on which leasehold reform should be measured is not the relative power of the leaseholder compared to the freeholder but cost and fairness. It may well be that one size does not fit all. While the 2002 Act on the surface looked to simplify the system, it only removed barriers and liberalised the market further.  If the government is to level the playing field, it must work hard to modernise the system that still relies on medieval feudal land ownership.  Cutting unnecessary costs and empowering lessees with a less daunting system is paramount. In addition, the process must be speeded up as most lease extensions occur when people are selling, as for many it is the only way that they can afford to raise the required capital cost. Back in 1967, the new Act was designed for the task and was 100% fit for purpose. In 2019? It must be simplified and more accessible. Eric Shapiro is a director at Chestertons