According to Government, The Leasehold and Freehold Reform Bill (the “Bill”) introduced to Parliament on 27 November 2023 will give long-leasehold homeowners a fairer deal, greater rights and more protection going forward. This is hot on the heels of the consultation published by Government on 9 November 2023 entitled “Modern leasehold: restricting ground rent for existing leases” (the “Consultation”) which may potentially lead to a re-writing of certain terms in existing leases.
This represents the next step of a potentially paradigm shift in the balance of power between freeholders and long-leasehold homeowners.
But what about the interests of existing freeholders and ground rent investors?
Key provisions of the Bill
At its core, the Bill aims to provide millions of homeowners with greater rights, powers, and protections over their homes. A key element and much touted part of the Government’s Long-Term Plan for Housing, the Bill seeks to address longstanding challenges in the residential leasehold system. Some of the key provisions are as follows:
- Banning the sale of new leasehold houses: meaning every new house in England and Wales would be freehold from the start, save in exceptional circumstances;
- Simplifying tenant rights: measures to simplify and reduce the cost of acquiring freeholds for leaseholders, including removing the requirement to pay the freeholder’s costs when making an enfranchisement claim, and removing the requirement or a new leaseholder to have owned their house or flat for two years before they can extend their lease or buy their freehold;
- Extended lease terms: increasing the standard lease extension term to 990 years for houses and flats (up from 50 years in houses and 90 years in flats), so leaseholders can enjoy secure ownership without the hassle and expense of future lease extension;
- Service charge transparency: introducing measures to enhance service charge transparency, with freeholders/managing agents being required to issue service charge bills in standardised formats, enabling easier scrutiny and challenge by tenants;
- Mixed use blocks: increasing the current floor space limit in mixed use blocks from 25% to 50%, allowing more leaseholders to qualify for rights to manage or rights to collective enfranchisement;
- Management: granting leaseholders more control over their property management decisions, by making it cheaper and easier for them to take over management and appoint a managing agent of their choice; and
- Redress schemes: broadening access to redress schemes, by ensuring that freeholders managing their buildings directly must belong to a scheme, providing leaseholders with a platform to challenge poor practice and also by scrapping the presumption that leaseholders pay their freeholders’ legal costs when making such a challenge.
The introduction of the Leasehold and Freehold Reform Bill reflects Government's ongoing desire to be seen to be addressing historical imbalances and creating a fairer housing market. Michael Gove, Secretary of State for Levelling Up, Housing and Communities, has previously referred to leaseholds as a “feudal form of tenure” and there have been countless horror stories in the press over recent years regarding, in particular, ground rents increasing exponentially leaving homeowners trapped paying huge costs and unable to move or re-mortgage. However, ground rents on new leases were effectively banned by the Leasehold Reform (Ground Rent) Act 2022, which came into force for most new leases on 30 June 2022. In addition, the Competition and Markets Authority has taken action to secure commitments from leading housing developers to remove onerous grounds rents from some existing leases and Government is now exploring a cap on existing ground rents through the Consultation.
The Bill contains measures designed to empower the owners of leasehold homes. However, there are concerns amongst freeholders and ground rent investors about how certain provisions may impact existing contractual agreements. The increased autonomy for leaseholders and the restructuring of certain aspects of property management raise questions about the potential clash with existing contracts and the delicate balance between legislative intervention and contractual freedom.
Freedom of Contract: a sacrosanct concept?
At the heart of English law lies the principle of freedom of contract; the idea that contractual parties are free to negotiate whatever commercial bargain they choose to, and that such bargain will, once the contract is in place, be enforceable in the English courts regardless of whether the contractual terms represent an objectively “good” deal for each party. This principle empowers parties to define their own legal relationships with minimal interference and the assurance of future certainty in contractual dealings is one of the primary reasons why many parties choose English law to govern the terms of their contracts.
This principle is not without its limits. Even in a legal landscape that highly values autonomy in contractual relations, there are some circumstances in which the English courts may intervene and declare a provision unenforceable – for example, penalty clauses, clauses contrary to public policy or under consumer protection laws.
However, the principle is generally treated as being sacrosanct and is seen as a fundamental pillar of our legal system. Any legislative changes which undermine this principle are, perhaps understandably, viewed with scepticism and concern by parties who might be directly adversely affected (and also by those parties who might worry about the precedent set).
We’ve already seen some erosion of the principle via the Building Safety Act 2022, insofar as it limits the ability of landlords to recover certain building safety costs from tenants. Many would argue that this is a reasonable exception, given that it relates to the safety of buildings and involves significant costs that individual homeowners are often simply unable to bear.
It is possible that there will be a further step down this road. On 9 November 2023, the Government published a consultation seeking views on capping ground rents in existing long residential leases in England and Wales. The Consultation, which closes on 21 December 2023, contains five options to cap ground rents in existing long residential leases as follows:
1. Capping ground rent at a peppercorn (i.e. nil);
2. Capping to an absolute maximum value;
3. Capping as a percentage of property value;
4. Capping at the original amount it was when the lease was granted; and
5. Freezing at current levels.
Note that the Consultation does refer to some of these options being subject to ongoing review (open market, indexation, etc).
Implications for the residential property sector
Freehold owners of properties subject to residential long leases include private individual investors, local authorities, pension funds, Real Estate Investment Trusts (REITs) and everything in between. Ground rents are a well-established investment asset class and paragraph 1.19 of the Consultation refers to a 2019 survey which estimated the value of ground rents held by the respondents was approximately £1.9 billion. Note that this isn’t the total value of ground rent investments; merely the value held by the respondents. The total value of ground rent investments in England and Wales is likely significantly higher.
Of particular concern to these investors will be the commentary in paragraph 1.84 of the Consultation:
“We understand that freeholders, collectively, would very likely lose revenue as a result of implementing a cap on existing ground rents. The scale of this loss may be dependent on which option of a cap was taken further. Regardless of the option taken forward, we would not expect to compensate freeholders for lost revenue, nor do we expect freeholders would be able to capitalise this lost income stream through other means”.
It is clear that the Consultation could have significant implications for the residential property sector; saving individual homeowners money whilst on the other hand causing potentially significant loss to investors. The outcome of the Consultation will determine where the line is drawn between those two points and it is likely that many stakeholders will want to respond to the Consultation before it closes. Those same stakeholders may well be questioning whether freedom of contract is now as sacrosanct as they may have previously thought it was.