The Freehold Group
Just one independent freeholder, a £56,000 investment, and the impact of ground rent reform
This case study examines the portfolio of one J4PR member, The Freehold Group, to show what the impact has already been of the proposed ground rent reforms on a portfolio largely made up of modest ground rents attached to typical residential flats.
We cover an example in Harpenden where the business bought for £56,000 the freehold of a building with 11 flats which is now estimated to be worth £19,000.
The two thirds valuation reduction raises a critically important question for policymakers: whether the crude and wide ranging legislation interventions are proportionate where the rent is low in relation to the value of the home and, in many developments, leaseholders already control the management of the building.
The portfolio behind the numbers
The Freehold Group has built a portfolio of ground rents, primarily acquired in the 1990s from UK house builders for retirement income. The portfolio consists of small purpose built blocks of flats with resident management companies, so the leaseholders have complete control of their maintenance and repairs.
The leases are long and rents are modest, under £150 on average, with reviews typically every 25 years. In other words, the great majority of the homes in this portfolio are examples of leaseholders currently paying ground rents already below the Government’s proposed £250 ceiling.
The Government is legislating to cap most existing residential ground rents at £250 a year and then reduce them to a peppercorn after 40 years. It says the policy is intended to address unregulated and unaffordable ground rents.
The Government has also acknowledged, in its consultation on negotiated “quid pro quo” leases, that moving rents to a peppercorn can transfer value from freeholders to leaseholders in some cases, while also arguing that a 40-year sunset period at the end of which the ground rent will legislated to reduce to zer, is a proportionate intervention.
For the Freehold Group, the estimated effect on capital value is substantial. Using valuation methodology used recently by Savills, the portfolio is estimated to have dropped by 68.5%.
These are the member’s own investment estimates and are not presented as an independent market valuation. They do, however, illustrate the scale of the economic impact the member says the proposed reforms have already had on the value of the portfolio.
In 2022 The Freehold Group decided to aquire a ground rent investment from a builder, having bought very few properties for decades.
Arden Court, Harpenden: a modest rent, but a major change in value
Arden Court is an 11-flat development in Harpenden. The freehold was acquired in October 2022 for £56,700, equivalent to approximately £5,155 for each flat. For many years the law has required in these circumstances for the leaseholders collectively to be offered the freehold at the same price in priority to the buyer, in this case The Freehold Group, but the leaseholders declined to do so..
The development produces total annual ground rent of £3,150, or approximately £286 per flat. With the flats estimated to be worth around £600,000 each on average, the annual ground rent is equivalent to approximately 0.048% of the value of the average flat. The rent review mechanism is also relatively infrequent: the rent increases by £150 per flat every 25 years.
The management arrangements make the example particularly relevant to the debate about what ground rent reform is intended to achieve. The leaseholders already control the management of Arden Court through a residents’ management company that is party to the leases.
The freeholder’s ground rent interest is therefore distinct from day-to-day management and service-charge expenditure. Reducing the ground rent does not give the residents management control that they previously lacked; they already have it.
The ground rent obligations were properly documented in the leases when the flats were purchased and every flat purchaser will have received legal advice prior to completion of their purchase. That does not resolve the wider policy debate about existing ground rents, but it is relevant to the question of proportionality when Parliament is considering altering the future income attached to an existing property interest.
The Arden Court freehold is now estimated to be worth £18,585. Against the £56,700 acquisition price, that represents a reduction of £38,115, or 67.2%. The immediate £250 cap would reduce the average rent by only around £36 per flat per year. The much larger effect on the investment value comes from restricting the future contractual income stream and ultimately moving the rent to a peppercorn after 40 years.
Arden Court therefore illustrates the issue at the heart of this case study. The ground rent is small relative to the value of the homes, the rent review occurs only once every 25 years, and the residents already control management and were given their first right of refusal to buy the freehold. Yet The Freehold Group estimates that roughly two-thirds of the value of the freehold investment has been lost.
The wider question: proportionality
These two developments do not by themselves determine where the balance of leasehold reform should lie. The Government’s stated case is that ground rents are payments for which no service is provided, that some have caused affordability and saleability problems, and that the reforms will simplify the leasehold market. The Government has also said that it has not seen convincing evidence that ground rents generally reflect a corresponding reduction in the premium paid by leaseholders.
What the Freehold Group’s portfolio demonstrates is that the effects of a universal policy are not confined to high or rapidly escalating ground rents. Most of the flats in this portfolio already carry average ground rents of £250 or less. In the vast majority of these developments, the residents already control management. In the example above, annual rent is less than 0.05% of the stated value of the flats, while the member estimates that the freehold investments have lost around two-thirds of their value.
Some of our other members who used bank finance with personal guarantees, now face personal bankruptcy as their banking covenants have been breached, their lenders are asking for repayment, and the values have dropped so dramatically they cannot realise sufficient from a sale to repay the loans.
This example clearly demonstrates the unintended consequencs of an erronious belief by government summed up by Mathew Pennycook on 15 July 26, “The leasehold system is blighting millions of lives.” This is simply untrue, thousands, but not millions may be suffering. This has been caused by a minority of poorly run managing agents and freeholders, who have exploited very different lease terms than those in this example. None of the leaseholders in Freehold Group style properties are “suffering” and the government’s sledgehammer policy is punishing professional investors who have no truck with profiting from unprofessional management or egregious rents.
It is also extremely puzzling why the new law includes expropriating rent after forty years and removing increases for inflation. How does this help with the cost of living? Indeed, It undermines confidence in Britian’s rule of law. Rent was considered to be an income stream that investors in the UK believed to be sacrosanct. That is why leading UK institutions, (including M&G who recently reported a significant valuation provision due to this law), rated ground rent investments as AA rated securities. How can this government state they wish to encourage a building boom and are seeking a substantial up-tick in GDP growth, when these proposals are already undermining confidence in the entire construction sector and will inevitably more widely sound a schreeching alarm to potential inward investors?
For J4PR, that is why the debate should include not only whether leaseholders should be protected from genuinely onerous ground rents, but also how reform treats existing property interests where the rent is modest and the lease terms are longstanding. The question is not whether leasehold reform should take place. It is whether the mechanism chosen distinguishes adequately between different types of ground rent and strikes a proportionate balance between the interests of leaseholders and freeholders.