Guest Blog: Why on earth do we have ground rents?

11 September 2017 |

Ground rents are certainly nothing to do with the rental value of the ground and, in most cases, simply an opportunity for a greedy landlord to get something for nothing.  The actual reason ground rents exist is to do with English law which requires that for every contract there must be consideration.    You might think that if one person gives another person £1m and the other person hands over the keys to their flat that is consideration, but the thing about leases is that they involve an enduring obligation and accordingly they require an enduring consideration.

Ground rents can of course vary enormously.  On the one hand you get the quaintly innocuous ones which provide for a peppercorn, or a red rose on midsummer’s day “if demanded”.   On the other hand, you get the sort of thing I encountered recently:  a flat in Elm Park Road geared to 0.5% of the capital value of the entire building. The flat itself represented about 15% of the value of the entire building and therefore on review the ground rent was due to be adjusted to 0.5% x 6.67% = 3.33% of the value of the flat.  That is as much as anyone on an Assured Shorthold Tenancy (AST) would currently expect to pay!

When I took on this job I was given the section 42 and section 45 notices which proposed £340,000 (the tenant) and £471,000 (the landlord).  Before coming to me my client had considered using another valuer, who had suggested that the correct target should be £445,000.  I said that I certainly expected to do better and, having stuck my neck out,  was very pleased several weeks later to be able to secure an agreement at £365,000.  But before I launch into a trumpet voluntary, it is worth appreciating that these ground rents are largely overlooked and misunderstood. 

I once acted for a solicitor who had bought a house in Radnor Walk with a lease geared to 1.25% of the freehold value.  This solicitor was entirely unaware that his lease contained this covenant.  OK, he wasn’t a property lawyer, but you might think he would have taken the trouble to read his own lease.  It is not as though they are written in Latin!  Alternatively, if he did not deal with the conveyance himself, you might think that the conveyancing solicitor might have thought it was worth pointing out.  Maybe he thought that would be patronising.   

But what then is the correct way to deal with these onerous ground rents when you are negotiating a lease extension or enfranchising a lease? You might think there was an Upper Tribunal ruling on this, but actually the most referred to authority is a local tribunal decision in 2005 called Millard Investments v Cadogan. In Millard it was suggested that where a ground rent exceeded 0.1% of the capital (ie freehold) value, then the amount of that excess or, as they called it “unpalatable”, ground rent should be applied to reduce the value of the leasehold. 

The trouble about this is that the landlord then gets his cake and eats it because, first of all he gets that much more for the value of the term income, and then he gets that much more again because the marriage value is widened. There has recently been quite an uproar in the press about developers selling leasehold houses with similarly onerous ground rents.  Companies like Long Harbour have been widely criticised for supporting this and there is a distinct possibility that such leases may be made illegal. 

Take, for example, a flat with a long lease value of £1,000,000 offered on a 150 year lease subject to an initial ground rent of £500 pa.  Nothing too shocking about that you might think. But look a little closer and you discover that the ground rent doubles every ten years of the term.  So after owning the flat for the requisite  two years you decide to apply for a lease extension, not because you are concerned about havingg 148 years left, but because you want buy out the ground rent.  

The value of income is arrived at by applying a discounted cash flow with an appropriate capitalisation rate, which will vary according to the quality of the income.  A ground rent fixed for the term is unlikely to be valued at anything lower than 7%, but a ground rent that doubles every ten years is going to be a very attractive income to some investor and might, in today’s market, be valued at a yield of 5.25%.  If so, that relatively innocuous ground rent of £500 pa would cost more than £300,000 to buy out, as demonstrated here.

Responsible landlords like Grosvenor gave up incorporating geared ground rents into new leases some time ago, partly because they were more trouble than they were worth and partly because, one would like to think, they did not want to associate themselves with that sort of practice.  

These seriously onerous ground rents are certainly becoming less prevalent, but there are still many leases out there with horrific ground rents which are perfectly legal.  Accordingly, when it comes to buying them out in the context of a lease extension or enfranchisement great care and expertise must be taken.