In our series of property investment for beginners articles, we focus on leasehold property. Leasehold property is not a common type of property around the world. But, if you look for property in England, you will see leasehold property everywhere.
Property investment for beginners – What is a leasehold property?
A leasehold property is a type of property where the owner (tenant) owns the property under a long lease. The lease is usually for 99 to 125 years for second-hand property. They are generally much longer for new build properties. In some situations, they can be as long as 999 years.
The tenant has exclusive rights to live in and use the property during the lease term. With a leasehold property, the tenant pays annual ground rent to the landlord. They also must pay their proportion of the cost to maintain the building. Referred to as service charges.
A leasehold differs from a freehold, where property is owned outright. And also differs from a tenancy where a property is rented on a periodic basis such as weekly or monthly.
Issues with leasehold
With a freehold property you own the land and the buildings on it outright. Whereas, with a leasehold interest, your interest is restricted to the time of the lease (term) and the area which is granted to the tenant (demised area).
A leasehold restricts the tenants access to the property to a predetermined period of time. At the end of the lease the property will revert to the landlord. This often implies that you have fewer rights than if you were the owner of a freehold property.
The majority of apartments in England are held in leaseholds. This makes sense because it enables the enforcement of reciprocal obligations and the sharing of costs, but some dishonest landlords take advantage of the system. Additionally, some new homes may have been marketed as leasehold just to give the developer another source of income that they can sell.
Increasing ground rents
You must pay ground rent to your landlord as a leaseholder in exchange for the right to use their property. In the past, ground rents have been small amounts of money. But, ground rents have evolved as large institutional investors have acquired them.
Some leases include unfair rent escalation clauses, increasing the annual rent over time. These clauses make the leases more valuable and attractive to investors. These investors buy them for pension funds for long-term stable income.
Most leases have rent review clauses that increase the rent in line with inflation. Or, in some situations, linked to a simple increase mechanism. Most of these reasonable rent review provisions do not result in significant increases. But investors must be careful because some allow for exponential increases over time. What starts out as a small amount of money can become a huge sum many years later. These unfair review provisions can lower the properties marketability and value.
Exorbitant service charge fees
Leases include service charges provisions to recover the tenant’s proportion of the cost of maintaining the communal areas of the building. These services must be expressly set out in the lease agreement. However, it is a common complaint of many leaseholders that the costs of service charges are unreasonable.
Obtaining permission to deal with the property
Many investors forget with leasehold; they don’t own the property, just the right to use it for the lease term. Some changes to the property, such as structural changes, will need the freeholder’s approval. In most situations, the landlord cannot refuse reasonable requests. But leases allow for them to recover their costs associated with considering the request. The process of gaining consent can take time and be unpleasant, and these fees may still be substantially more than you expect.
Obtaining permission to deal with the property
Many investors forget with leasehold; they don’t own the property, just the right to use it for the lease term. Some changes to the property, such as structural changes, will need the freeholder’s approval. In most situations, the landlord cannot refuse reasonable requests. But leases allow for them to recover their costs associated with considering the request. The process of gaining consent can take time and be unpleasant, and these fees may still be substantially more than you expect.
Leases are a ‘wasting’ asset
A lease is a depreciating asset, unlike a freehold. Leases are worth less the shorter the remaining period of the lease term which remains. Once the remaining term of the lease is less than 80 years, it can be more difficult to sell the property and get a mortgage.
You might not own as much as you think
What you own should be stated in the lease, your demised area. Sometimes leases can be convoluted and confusing. This can create issues if there is a disagreement over who is responsible for structural repairs.
Potential Leasehold reform
The Law Commission is thinking of ways to make it simpler for leaseholders to renew their lease or buy the freehold. The government is also considering methods to improve the equity of the leasehold system. These include limitations on the amount collected through ground rents and a ban on the unjustified use of leasehold for new homes.
The reality is nothing moves quickly in the real estate market. This reform will likely take many years.
The bottom line
As an investor, the bottom line is you need to do your own due diligence. Read all the documents you receive and do your homework. If something doesn’t make sense, ask questions and if your not happy with the answer, move on. It is not worth being stuck in unfair leasehold agreement.
Are you thinking about buying an investment property in the UK?
If you are thinking about buying a property in the UK, you need to make sure you do your homework before you buy. Mistakes made investing in property are very expensive to fix. We have built Du Val Global to help investors think through the issues which matter when it comes to investing
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You might also be interested to read our article, 5 investment strategies you probably haven’t thought of.
