Leasehold reform remains elusive

Leasehold watchers may be forgiven for feeling somewhat war weary. Last month, newspaper reports circulated that secretary of state for levelling up, housing and communities Michael Gove’s plans for new legislation this autumn had been rebuffed by Number 10. By that time, it will be well over 20 years since New Labour introduced a new ownership model to replace the long-standing freeholder/leaseholder relationship: that of commonhold, which came on to the statute book with the Commonhold and Leasehold Reform Act 2002.  Commonhold is often discussed, but infrequently adopted, with only a handful of examples in England and Wales. Leasehold homes still dominate where apartment living is common. Of all residential transactions in London in 2021, 50% were leasehold, as were 35% of those in the North West.  Fast-forward from 2002 to 2017 and it was Theresa May who asked the Law Commission to investigate further reform. What we have seen since is not radical change, but a slow market adaptation to piecemeal legislation. Adapting income streams The most significant reform within the past decade has been the Leasehold Reform (Ground Rent) Act 2022, which prohibited ground rents from new leases. The 2022 Act responded to the fallout over the selling of leasehold houses with onerous clauses allowing for serious uplifts in rents.  These changes have been felt differently across the sector. Where rents were low in any case, the actual financial impact on the freeholder is minimal. Larger portfolio owners may feel differently when assessing the implications at scale. Something has had to give and increasingly it is the burden of day-to-day management responsibilities that historically sat with freeholders.  The 2002 Act introduced the principle of resident management through right to manage, a mechanism for residents to set up a company to provide management services themselves. Faced with changing investment returns, we are now seeing freeholders proactively endorse this model. Developers bringing schemes to market are increasingly establishing resident management committees from the outset.  Despite the appeal, this “freehold-light” model is not problem-free. RMCs set up residents as company directors with responsibility for the building, liaising with the freeholder for consents required. Inevitably, many lack the time, resource or expertise to properly undertake these responsibilities.  This creates costs for professional advice and risks for both parties, especially when it comes to building safety, which is a critical concern yet also a serious headache for both RMCs and freeholders. Even with management devolved, the freeholder in most cases retains ultimate accountability under the new regime. That entails assessing risks, ensuring the right information is kept about the development and engaging residents with up-to-date and relevant safety information.  Future-proofing positions The growth in RMCs shows leasehold’s ability to adapt, but it is no panacea to the fundamental difficulty of managing complex assets. However, it seems as though the appetite for wider reform in the final months of the current parliament is fading.  While reassuring for some investors, this makes it harder to take a long-term view. In 2020, the Law Commission finally set out recommendations on how to reinvigorate commonhold as an alternative to leasehold. The government’s response at the time was that it would look at these proposals “in due course” – kicking them into long grass that has only grown since. Precedent is for recommendations made by the Commission to eventually become law, and this could come back as part of a new legislative agenda from whichever party is in power in 2024/25. Shorter-term, the government is more likely to look at the issues around enfranchisement – extensions to existing leases. Here the system can be bureaucratic and lack transparency when it comes to costs. The proposals, in summary, are to introduce a default lease extension length of 990 years – setting ground rents at a peppercorn as per the 2022 Act – and to abolish the controversial concept of “marriage value”, whereby extensions to leases falling below 80 years trigger an additional round of fee negotiations designed to capture a portion of the value created through the lease extension for the landlord.  These measures may still appear in a King’s Speech this autumn. These steps would erode revenue streams, reducing the attractiveness of freehold investments further for some owners. On the other hand, these enfranchisement changes are unlikely to cause great concern for professional portfolio investors.  Income from ad hoc lease extension events is hard to forecast and can be an administrative burden. Clarity on the extent of legislation and its timetable would be welcome.  Assessing alternatives Against this backdrop, investors would not be blamed for looking at diversification. Build-to-rent models in particular are more and more attractive and British Property Federation data shows this market has grown by 9% in the first quarter of 2023 alone. BTR has similar attractions to leasehold when holding assets for long-term value, but with clearer income forecasting. This class can also appeal to green investment, where good governance, tenant satisfaction and oversight of sustainability performance across a portfolio matters. Management models are necessarily hands-on, but effectively baked-in to the business case rather than being seen as an inconvenience.  A wholesale overhaul for leasehold feels distant. A “reinvigorated” commonhold would not take sway overnight, even if legislated for, and bar some very radical policy from either of the leading parties, leasehold will likely remain a valuable part of portfolios for many decades to come.  Nonetheless, as categories like BTR come of age in the UK, we should expect to see investors assessing their options. James Duncan is a partner and head of real estate investment at Winckworth Sherwood Image © Andrew H Walker/Shutterstock