Who came up with the wheeze for housebuilders to retain freeholds on the sale of a house and charge the new leasehold owner a (seemingly innocuous) ground rent that doubles every ten years? And how did they get away with it?
It’s a game that will soon be up when legislation outlaws the practice, following a passionate crusade by the National Leasehold Campaign (NLC).
But some beneficiaries of this large and lucrative industry are still unwilling to acknowledge its demise. Just to be clear, the beneficiaries are generally: (1) housebuilders who sell only the leasehold to new homeowners, retaining the freehold to sell at a further profit, and; (2) the companies who buy those freeholds and are then free to charge homeowners ground rent and “management” fees at whatever level they choose to set.
Unfortunately, despite the protests, this is hardly a new story. The battle has been long and nasty. The Guardian kicked up a fuss about it over three years ago, spotlighting a company called E&J Estates, which it found is one of “an extraordinary web of 85 ground rent companies” owning the freeholds of more than 40,000 homes across England and Wales”. You may like to read it before continuing [Ref1], but I’ll summarise below.
At that time, The Guardian reported, this entire empire was controlled by a sole director named as James Tuttiett. Just one of Tuttiet’s companies, SF Funding Ltd, showed an £80m jump in the value of its ground rents from the previous year, taking turnover to £267.4m. That’s just one company reportedly owned and run by this one man.
“An unjustifiable way to print money” – Sajid Javed
His leaseholders (and lest we forget, these are people who have bought their own homes, usually taking on a big mortgage to do so), have not entered into any voluntary agreement with Tuttiett, but are obliged to either pay him ground rent or hand over the deeds to their home. The scandal came to light as momentum grew behind the NRC campaign and complaints from residents allegedly approached “panic” levels at the realisation that, even after they had fully paid off their mortgages, many of them would still be paying tens of thousands of pounds a year to live in their own homes after retirement [Ref1, para 8]. Others have complained that the exponential escalation will make their homes unsaleable in a few years, since what buyer would take on such a mounting burden? [Ref1, para 9] It’s been likened to an arranged marriage – except you can’t get an amicable divorce.
As Katie Kendrick of the NLC says, “England and Wales are among the last countries in the world where you can buy a property, but don’t ever own it. People’s homes should be theirs alone and not an asset for people to invest in and trade. That is the position elsewhere in the world”.
It’s a scandal that prompted Sajid Javed to comment on BBC Radio 4’s Today programme, “Enough is enough. These practices are unjust, unnecessary and need to stop,” adding that the methods used were “an unjustifiable way to print money”.
But further investigation reveals that E&J are far from the only floater in the pool. Even a cursory trawl of TrustPilot will show levels of dissatisfaction in some of these companies that would make it impossible for them to continue if their “customers” were not bound to them for life [Ref2]. And there are literally hundreds of these companies, all making easy money without creating a penny of extra value for their inmates.
Because of course, the chiselling doesn’t stop at the ground rents. No sirree. To misquote Teddy Roosevelt, when you’ve got them by the balls, you can empty their pockets. E&J charges its leaseholders fees for such “services” as allowing them to sublet, or add patios and conservatories to their own homes [Ref1, para 19]. An Englishman’s home, it seems, is not his castle if there’s a robber baron in a bigger castle taking his cut.
And when I say easy money, you will be alarmed, gentle reader, at quite how easy it is to turn a buck in this gilded world. Buying up ground rents from new-build homes is arguably a better investment than gold: it brings a steady income stream, you never have a bad debt (you can simply turf the owner out of his home and flog it to pay your own bill) and you don’t have to provide even a half decent service because… well, see above.
Which means the banks have historically fallen over themselves to lend money to these neo-feudal barons at ultra-low interest rates. Tuttiett, for instance, managed to borrow £128 million at a reported rate of 0.95% (although admittedly the actual rate he’s paying is probably a shade higher) [Ref1, para 13].
So it should come as a surprise to no-one that the Competition and Markets Authority is now taking enforcement action against the most prominent offenders [Ref5].
Better still, the campaign and its surrounding furore have led directly to changes in the Help to Buy Scheme – which in turn has forced five of the UK’s biggest housebuilders to scrap ground rents on new flats, and to desist from selling-on freeholds.
“Developers have not taken this decision because it’s the right thing to do” points out Katie Kendrick. “They are being forced to change their poor practices because the applications for the new Help to Buy scheme opens from the 16th December and Homes England have stipulated that ground rent charged must not exceed a peppercorn.”
So where appeals to their conscience have failed to move the big housebuilders, financial constraint appears to be having an effect. There’s still a long way to go to dismantle this distasteful practice, but the first bricks have been chipped from the wall.
Are we anti-developer? Is a weather vane anti-wind?
Of course, some freeholders have put on a good show of acting surprised, even going so far as to accuse us of being anti-developer, merely for pointing out which way the wind is blowing. Is a weathervane anti-wind?
We’re highlighting this because it is going to happen. It’s quite simply our job to know the direction of travel and alert developers to take care what they spend on sites going forward. Freehold owners may carp and cavil (and by golly they will) and protest that the practice isn’t as widespread as people think; that most captive leaseholders must be content with their lot because they haven’t yet risen up and put the freeholders’ head on a pikestaff. But of course, when you ask them for hard figures, or details about these happy leaseholders, they ooze away into the darkness again. And anyway – what leaseholder will put his head above the parapet when his balls are in a vice? The Guardian itself cited difficulty in putting names to quotes since many people trapped by ground rents prefer to remain anonymous while they negotiate.
However – leasehold reform has been on the agenda for quite a time now and has gathered pace as awareness burgeoned in the last couple of years. In July, the Law Commission unveiled a comprehensive set of measures to give leaseholders the full rights to the homes they paid for. The NLC’s submissions persuaded the body to endorse reforms it had previously ruled out, extending the benefits to even more leaseholders. The government’s senior legal advisors went as far as recommending that commonhold, a scheme for the freehold ownership of flats successful in other parts of the world, be the “preferred alternative” to leasehold.
So those in the know generally expect ground rents to be capped or abolished altogether. We have a government with a substantial majority, 4 years remaining in office and this is a popular, vote-winning policy. With a senior housing minister using words like “unscrupulous” and “pernicious”, the writing is very much on the wall. Developers and their funders will have to adjust. Most have already.
So let us lay our cards on the table. At CapitalStackers, we are proactively, practically and passionately pro-developer. Many developments simply wouldn’t happen without our advice and service, which is more than can be said for the ground rents “industry”. We put together deals that work and otherwise might fail. Our pricing is fair and market-driven, so that both developers and investors come back time and again to us.
But we’re also pro doing the right thing. If Mrs Miggins is being fleeced simply for living in her home, we don’t want a part of it, so in our view, regulation is no bad thing.
Thus, we can safely say that none of our developer clients has sold houses on leasehold in order to extract more profit by packaging and selling the ground rents. The law will prevent it in the future anyway, not that they would consider it. We’d like to think they share our values of fair play.
In the interests of open declaration, we do have clients who’ve built flats and sold leaseholds to buyers, packaging and selling ground rents to a freehold investor because that was the accepted practice at the time. But again, we can state honestly that none of these clients would have entertained onerous leasehold terms.
We, and the senior lenders with whom we collaborate on deals (i.e. banks), have not incorporated the capital value of ground rent sales in development appraisals for some time now – mainly because proposed legislation could wipe out the value. It would be lunacy to lend against it. It’s unfortunate for those developers who have bought sites on the expectation of selling ground rents, but that’s commercial life. There is some comfort in the fact that ground rents aren’t normally a significant part of a project’s Gross Development Value.
The likelihood is that legislation will force ground rents down to zero. As that happens, the Residual Site Value will fall and developers will adjust the amount they pay for sites. There will be a relatively short-term adjustment period for developers.
Our developer clients’ interests are perfectly aligned with ours – in that they too want to produce stock that will sell.
That means it must be mortgageable.
When this situation started unfolding, led by the Nationwide Building Society, mortgage providers changed their lending policy en masse. Almost overnight, they refused to lend against leasehold security where the ground rent was more than 0.1% of the capital value of the property. This left thousands of owners unable to sell because buyers couldn’t get a mortgage. This, of course, included some of their own existing customers – so ironically, they were already lending against property they wouldn’t lend against for a new buyer! Doh!
However, even today, some freehold buyers are still putting out terms which will fail this basic 0.1% mortgage criterion. Are they really that naïve? We’re in the golden age of disruption. There’s now a perfect opportunity for them to set out their stall to offer fair pricing, exceptional service and best-in-class communication. To swap avarice for an enhanced reputation and treat their captive audience with the humanity everyone deserves. We hope more and more of them will.
So we’re shining the spotlight on how we got to where we are now, what’s currently happening and trying to join the dots to work out how it will unfold. And that’s not difficult. Here are our top tips for developers:
- If you build houses – only ever sell your buyers the freehold.
- If you build apartments, work on the basis that ground rent will be nil. If it turns out to be more, doubtful though that is, it’s bunce. Until there is absolute clarity, don’t factor ground rents into your development appraisal – and buy sites based on the resulting residual site value.
- Keep up to speed with the Law Commission and Government progress.
- Steal a march on the competition and only sell leasehold interests on fair, buyer-friendly and, above all, mortgageable terms.
- If you have to sell the freehold to investors, limit yourselves to the reputable ones – those with a decent score on TrustPilot. A leaseholder can’t choose their landlord. They’re stuck with them for evermore, unless they band together and buy out the freehold.
- Anticipate that the proposed Commonhold alternative will be adopted at some time in the future.
All the above will enhance your reputation in the residential development world. You’ll become one of the ‘good guys’ and make your finished properties easier to sell. And that’s great for you, your funders and Mrs Miggins.
Everyone wins, except the Robber Barons.
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