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Ground rents – sound rents?

Why would any investor or developer want to own ground rents? – seemingly anachronistic low rents – relics of when landed estate owners in earlier centuries leased land at a ‘ground’ rent, rather than at a ‘rack’ or ‘market’ rent, to speculative builders to enable them to develop the land – thus ensuring the landowners received an income whilst the development was carried on. Time and inflation, however, have eroded the value of those ground rents as most were not subject to review. Why then do so many wish to invest in them?

Indeed, far from being a Victorian practice, in recent times, more and more ground rents have been created as landowners and developers developed large estates where the units were sold off on a long leasehold basis for a premium but subject to a ground rent. Indeed in the ‘boom’ years for development running up to the recession millions of new ground rents were created resulting in millions of pounds’ worth of rental income for those developers and investors who retained the freehold and ownership of the ground rents.

Investment in property has long been a sound investment but in recent years owing to the poor economic climate, the value of such investment has faltered. By contrast, however, investment in ground rents has not been affected by the recession and lack of fluidity in the mortgage market and is seen by most financial advisors as an increasingly sound investment.

It may not, however, be in the economic interests of a small investor to own ground rents but for larger scale investors or developers with sizeable portfolios of ground rents then this sort of investment can prove not only to be sound but also recession-proof. Before the recession took hold many developers or ground rent owners may have been ambivalent about the income derived from ground rents and may not even have bothered to collect in the rents but now that the development potential and the finance with which to undertake it has been curtailed in this economic market, ground rents are being recognised as a viable source of income and a sound investment.

The reason for this is that ground rent ownership provides a secure income (by way of the rents generated – albeit individually low) and also the low risk profile most investors seek. Such ground rent investment is an ideal way to diversify portfolios and manage exposure to the vagaries of the property market in a low risk manner. The reason the risk is low is that the investment is secured in every case against the value of vacant possession of the long leasehold interest.

The worth of ground rent ownership is a combination of the rental income and the ever increasing value of the decreasing terms of the long leasehold interests. In most modern leases the freeholder or developer should seek to review the rent upwardly as this has a beneficial effect on the rental income for the ground rent owner.

But ground rent ownership also provides other income streams in addition to rent which enhance the attraction of such ownership, for example:

  • Lease extensions – as the lease term gets shorter and, as a result, the ability to secure mortgage lending declines, so the value of the ground rent ownership increases as, subject to statute (Leasehold Reform, Housing and Urban Development Act 1993), ground rent owners are able to secure a capital payment from leaseholders in return for the grant of a new lease; or
  • Management fees – in most leases the leaseholders require the consent of the ground rent owner/freeholder for assignments; underletting; alterations and works to the property; certificates of compliance for Land Registry purposes on sales of the property – all of which can produce an income for the production of those consents; or
  • Development potential – ground rent owners may be able to take advantage of the possibilities afforded by spare land at the development or flat roofs or unused buildings to create and develop more units to derive substantial capital and additional rental income; or
  • Insurance commissions – most leases provide that the freeholder/developer effects the insurance for the whole block thus affording a chance to negotiate insurance commissions with the insurance company on the premium; or
  • Interest on late payments – most leases provide for interest to be charged on late payment of ground rents accruing from the date they fell due and usually at a rate of 4% above the base lending rate of the bank specified in the lease. This sum could easily be considerable if there has been ineffective collection in the past; or
  • Administration charges – if the lease permits administration charges can be levied by the ground rent owner on late payers and, again, this could be a considerable sum if arrears have been allowed to build up.

As can be seen, therefore, ground rent ownership is a valuable investment opportunity but one that is readily traded should the owner wish to raise funds for other acquisitions or to raise capital generally.

It should be noted, however, that there is a statutory bar to selling on ground rents/reversionary interests without first giving the leaseholders the right of first refusal to acquire. The Landlord and Tenant Act 1987 obliges owners to serve a ‘Schedule V’ notice on all qualifying tenants offering to sell them the reversionary interest on the same terms as it wishes to sell to any other party. Those tenants have two months within which to respond and a further two months to nominate a purchaser if they are interested in proceeding – if they do not respond within the requisite time frame then the sale may proceed to the other party as normal.

If retaining ownership of ground rents then owners should be aware of the practicalities of securing the payment of the rents. Section 166 of the Commonhold and Leasehold Reform Act 2002 provides that long leaseholders are not liable to pay ground rent until the landlord has given them a statutorily prescribed form of notice advising of the amount and date for payment of the rent. This notice must also contain other prescribed information. For a template of a demand for ground rent Click here to view.

The limitation period for collecting ground rents is six years from the date the same fell due for payment (section 19 of the Limitation Act 1980)

The ultimate sanction for non payment or persistent arrears is forfeiture of the lease provided the sum outstanding is greater than £350 or the sum has been outstanding for three years or more.

SLC Solicitors are experts in ground rent arrears recovery working as they do for major ground rent portfolio owners and developers in this niche area. We can also provide assistance to ground rent owners with management services such as licences to assign and underlet; deeds of consent for works and alterations and provision of Certificates of Compliance for Land Registry purposes on sales. We also have the expertise to provide guidance on the Section V notice requirements and sales of ground rent portfolios.

For more information please contact Jo Green on 0333 0 300 200 or email at jcg@slcsolicitors.com.

Click here to download a print ready PDF of this guide.

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