Jonathan Bower

Addressing ground rents in the short-term finance sector




There has been no shortage of comment over rising ground rents.

While this undoubtedly brings to the fore issues of fairness, one unexpected consequence of this is that high ground rents can have a dramatic effect on the existence of the lease itself and, therefore, its’ security for a mortgagee.  

The issue runs back to the Housing Act 1988. Without getting technical, this is the legislation that created (among other things) assured shorthold tenancies (ASTs). Briefly summarising, the act states that where the tenant is in possession of the property and there is a rent of more than £1,000 a year (in Greater London or £250 outside London) the tenancy is to be treated as an assured shorthold tenancy.

Now you may be wondering what all this has to do with security? The answer is to do with non-payment of rent. Let’s take as an example a simple residential lease with a ground rent of, say, £200 per annum. If the tenant failed to pay this rent and faced the possibility of losing their lease, the tenant or their mortgagee could apply for relief from forfeiture from the courts, whereby they would pay the arrears. With ASTs, the process is dramatically different. Where rent is not paid, the landlord determines the tenancy using one of the mandatory grounds of section 8 of the Housing Act. Crucially, section 8 does not afford any right to relief from forfeiture. The lease simply is extinguished and the landlord can obtain an order for possession. The courts have no discretion to award any relief from forfeiture as such relief does not exist in this regime, there’s no flexibility for them to do anything except assist the landlord in regaining possession. The tenant and their mortgagee is left without recourse.

So, for a lender, this is a serious issue. Short of investigating whether your mortgagor is in possession of the property and somehow ensuring that all rent is paid on time, lenders are really left quite helpless. You can, of course, put all manner of covenants in your loan agreement stating that the tenant will always pay the rent and won’t occupy the property, but the simple fact is that if the tenant doesn’t pay and does occupy, the lender’s security is at serious risk.

You might at this point be thinking why on earth would the government in 1988 have introduced such legislation? Well, at that time, the draftsmen did not foresee ground rent on a long residential lease ever exceeding the then exorbitant sum of £1,000. This issue has not escaped the attention of the Department for Communities and Local Government, who in December 2017 issued a statement that the government “will take action to address this loophole and ensure that leaseholders are not subject to unfair possession orders”. However, in October 2018, the eagerly awaited government consultation “Implementing reforms in the leasehold system in England” was remarkably silent on this issue.

And so it remains. The insurance market has also picked up on this with cover now available for forfeiture of lease (housing act repossession) indemnity insurance. However, the cover available is mortgagee-only and not for successors in title, meaning that in an enforcement scenario, the lender would not be able to offer this cover to a purchaser.

A recent lease I reviewed contained a ground rent provision of £1,500 per annum. Once the landlord was alerted to the issue, the clause they suggested to include in the lease was that where the tenant was in breach of their obligations to pay rent, they would pursue by way of commonhold and leasehold reform act forfeiture proceedings rather than by way of housing act determination. However, such a clause is arguably meaningless. If the lease contains a rent exceeding the low rent threshold and is interpreted as an AST, the landlord has no option to decide which manner to enact forfeiture proceedings and must determine the lease in accordance with section 8.  

Some developers have become aware of the issues and the potential negative press they would receive should they attempt to determine a lease on these grounds. However, I recently saw one lease from a national housebuilder which contained an interesting clause. While the ground rent was stated to be a peppercorn, as well as the usual service and maintenance charges, the lease contained a fixed estate charge. This charge started at over £1,150 per annum and was reviewed in an upwards RPI-linked manner. In short, it was a ground rent in all but name and arguably would be treated as such. Interestingly, if the tenant was to enact a statutory lease extension, this charge would not have been reduced down to a peppercorn.

So, in my opinion, as it stands, the advice to lenders would be not to lend on any lease which currently falls foul of the low rent threshold or has the potential to do so in the next 50 years or so.

 

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