Whenever flats are built, whether that be in a purpose-built block or through a house conversion, there will be an opportunity for developers to create and sell ground rents in addition to the properties themselves. This is because current property law requires flats throughout England and Wales to be leasehold. And as leasehold is a form of tenancy, it is subject to the payment of a rent, which in this case is ground rent.
This ground rent will be paid by the owner of the new flat to the owner of the freehold (the landlord) on an annual basis. With a guaranteed yearly return, which is legally enforceable, ground rents can be a very attractive investment for the right individual or company. However, just how lucrative these ground rents are depends on the structure of the leases.
How to structure leases
Every leasehold property in England and Wales must have a lease in order to set out the terms of the tenancy. As the developer and the owner of the land, you are effectively the landlord and you will, therefore, be required to create these official documents in order to sell the properties, and the buyers will register them with Land Registry.
The lease states the number of years that the lessee is entitled to live in the property, the rights and obligations of both the lessee and the landlord and of course, the amount of ground rent payable, the date on which it must be paid and any rent reviews or increases. It is essential to get the structure of leases correct as they can impact the saleability of both the flats and the ground rents.
The number of years that the lessee is entitled to live in the property is a crucial element of the lease because it has a significant impact on the value of the ground rents. Lease terms are commonly set at 99 – 125 years, however, some stretch to a massive 999 years. Although an exceptionally long lease term like 999 years may seem appealing to the leasehold property buyer, it removes potential income from extending leases.
This is because the only income that the landlord will receive will be from the payment of the ground rent itself and not from any fees to extend lease terms. In actual fact though, a leasehold property with a lease term of 99-125 years is just as valuable and saleable as a property with a 999-year term.
Most importantly, leases should not contain onerous lease terms, for example, where ground rent doubles every five years. Although this would appear profitable for the landlord, it would make the flat incredibly difficult to sell, not least because the majority of lenders won’t grant mortgages against these types of contracts.
The same problem will occur if you set ground rent above the current UK cap of £250 or £1000 in London. This action effectively turns the leasehold agreement into an assured tenancy, which will mean that it’s easier for landlords to gain possession of the property if the ground rent isn’t paid. Therefore, these contracts are considered too risky for most lenders.
So, leases not only need to contain fair terms for both the leaseholder and the lender, but they also need to be profitable for investors so that you can primarily sell the ground rents and achieve a good price. Not forgetting, of course, the many legal requirements that the lease will have to adhere to. Taking all of these factors into consideration, it’s clear to see that structuring leases is a tricky business to get right.
If you require any help with this, the team here at Freehold Sale are available to assist you. As ground rent investors, we understand which terms need to be included in a lease in order for a property development to be lucrative for both you as the developer and for a ground rent buyer.
We will provide you with expert guidance, tailored to the needs of both you and your development. This will ensure that you achieve the highest saleability of both the flats and the ground rent, so that ultimately you receive the maximum return on your investment, whilst ensuring that the leases contain fair and non-onerous terms for leaseholders.
Selling ground rents
Once you’ve managed to sell the leases in your development, you’re in a good position to start selling the ground rents. There is a range of selling routes that you could take including auction houses, private investors and specialist ground rent buyers. Each will vary in the time scales for the sale to complete, fees and charges, service level and of course, the valuation and capital that you receive from selling the ground rents.
With so many differences, it’s advisable to do your own research to discover which selling avenue will be the most beneficial for you. However, one important step to take before approaching any buyer is to have your ground rents valued. This will provide you with a figure that you can use to compare the potential return from the different selling avenues or any capital offers from buyers.
How to value ground rents
Ground rents are valued based on a number of key factors, most of which will be found in the lease documents for each property. These can include but are not limited to:
- The ground rent payable
- The terms of each lease
- The location of the ground rents
- The value of each of the properties
- If the ground rents have review clauses
There are a few different ways that you can value ground rents, but the fastest option is to use an online ground rent valuation calculator. It’s free to use and will provide you with a good estimate of what you can expect to achieve from the sale of your ground rents. However, it’s important to remember that valuing ground rents is complex, so the result that you get from the calculator will be an approximate value only.
An alternative option is to use an appraisal service from a competent ground rent buyer like Freehold Sale, who offers this service for free. You may find that other appraisal services come with a fee. Lastly, you can employ a surveyor to provide a valuation of your ground rents. This is the most expensive option but will also be the most accurate.
Legal requirements when selling ground rents
Before you can move forward with the sale of your ground rents, you will need to offer any qualifying tenants the Right of First Refusal. This is a legal requirement under Section 5 of the Landlord and Tenant Act 1987, which provides tenants with the opportunity to collectively purchase the ground rents.
The Right of First Refusal is offered by way of an official Section 5 Notice. Qualifying tenants are then given just two months to respond to the offer before a sale to a third party can go ahead. Failure to serve the Section 5 Notice in the prescribed format is a summary offence, which can result in a criminal conviction and a fine of up to £5000. You will also have to undo the ground rent sale transaction and bear all of the costs for doing so.
With so much to lose, Section 5 should not be ignored and it’s not worth taking any risks with the notices. To help you comply with your legal obligations, Freehold Sale offers a free Right of First Refusal service where we act on your behalf to serve Section 5 Notices to your tenants. We ensure that all procedures are followed correctly so that you can confidently proceed with the sale of your ground rents.
Selling ground rents before completing the development
Much like the properties that you are building, it’s possible to sell the ground rents before the development has been completed and the properties have been sold. This is an ideal solution for improving cash flow during the property development phase to enable you to meet time scales.
It’s likely that investors will seek a discount for purchasing the ground rent before the properties have been sold, as they won’t receive any returns on their investment for a considerable amount of time. However, if the leases are structured correctly, you could still receive a significant cash injection for your property.
This doesn’t necessarily mean that the leases need to be formalised for each property. The agreed lease terms can simply be set out in a contract which you will sign to ensure that you will honour the agreement. There will also be lengthy terms and conditions that you will need to observe and failure to comply with either can result in court action and substantial fees and losses. So, this is not a route to take if you are not confident that you can fulfil your obligations to the ground rent investor.
Lastly, although the ground rent investor will provide you with the capital in return for the signed purchase contract, the transaction will not complete until all of the properties on the development have exchanged. Therefore, they will not have any liability over the development and importantly, you will retain the revenue earned from the sale of the properties.