Freehold, Share of Freehold or Leasehold - Which Is Better?
Ah…
The Leasehold System…
It certainly has its pros and cons.
This post is an unbiased opinion on the pros and cons of leasehold properties, share of freehold properties and freehold properties.
I deal with leasehold, share of freehold and freehold properties and understand the pros and cons of each kind of property.
Historically speaking, owning land was a clear way of sorting social structure amongst society. It was literally the main asset in which people gained and earned social status.
The phrase ‘landlords’ literally comes from Lords owning land.
The leasehold system is part of the reason why London is, in my opinion, one of the greatest cities in the world, due to the fact that these ‘estates’ are managed and maintained at an incredibly high level.
Belgravia and Pimlico are prime examples. They are next door to one another and have very similar buildings, however Belgravia is one of, if not the prime area in London, whereas Pimlico has deteriorated over the years.
Both Belgravia and Pimlico were developed by Thomas Cubitt, who was famous in the property industry at the time for his buildings, for the Grosvenor family.
The Grosvenor family sold Pimlico in the 1950s to pay for the old Duke of Westminster’s death duty taxes.
Belgravia is still owned by the Grosvenor Estate, and is a beautiful part of London, whereas some areas of Pimlico have deteriorated, considerably.
Over time, Richard Grosvenor came up with the unique idea of selling long leases, instead of simply selling the properties, which is what had always been done previously.
Leases allowed a range of working-class families to able to live and work on certain sections of the land for a fixed amount of time – a ‘lease’.
Landlords, such as Grosvenor, began renting out land for fixed periods of time, which back then were typically for 99 years (and received a sum while retaining land ownership).
A lease and a leasehold property means that you have the right to occupy the property and have use of the property for a set period of time.
However, the freeholder owns the land that the property sits on, which has resulted in people quite rightly wanting to buy the freehold or a share of the freehold for their property.
The Leasehold Reform Act of 1967 was the first significant Act of Parliament which allowed owners of long residential leases to buy their freehold, however, it only applied to houses, and less expensive houses at that.
In 1974, it was decided that owners of more valuable houses with leases would be able to buy their freeholds.
Then, in 1993, The Leasehold Reform, Housing and Urban Development Act meant that the freehold of houses of any value (importantly, the most expensive ones) were available to purchase outright and flat owners had the right to extend their lease on their property for a fee, meaning that they could continue to live in their property.
The Leasehold Reform Act of 2002 meant that any property would automatically qualify for a lease extension if it had an original lease term of 21 years or more, and that the owner had owned it for two years or more.
Freehold properties require clear separate boundaries, such as in a terraced, semi-detached and detached properties, otherwise they can only be classed as a leasehold property.
A lease is a contract that is between the purchaser (the leaseholder) and the landlord (freeholder) that gives ownership to the leaseholder for a set period of time.
When buying any property, but in particular when buying a leasehold property, PLEASE make sure to speak to a solicitor as it is incredibly difficult to change the conditions of the lease once you have bought the property and signed the terms of the lease.
The lease simply sets out the obligations of both parties.
The leaseholder’s obligations include but are not limited to:
· Paying ground rent and service charges – ground rent is a payment to the landlord because the leaseholder is a tenant. Service charges are payments to the landlord for all of the services that they provide.
· Contributing to maintenance and management costs.
· Contributing to insurance costs.
· Certain criteria for use of the flat/ house – leaseholders are not free to do whatever they please in their flat.
When a leasehold flat changes hands during a sale, the seller passes all of the obligations of the lease onto the purchaser, which can include any future payments and outstanding charges.
As previously explained, if you were to purchase a leasehold property, you own a long-term tenancy, which is the right to use the flat for a set period of time, which nowadays is usually 99 years or 125 years.
If the lease was to run down fully, the flat would simply return to the landlord.
“A lease is a contract between the purchaser (the leaseholder) and the landlord (freeholder) that gives ownership to the leaseholder for a set period of time.”
The pros and cons of leasehold properties are:
Pros of Leasehold
· The cost of purchasing a leasehold property is generally less than purchasing a freehold property.
· You tend to have less responsibility with things such as maintenance and repairs.
· There is the possibility of purchasing the share of the freehold in the future.
Cons of Leasehold
· You pay ground rent, service charges (which can often be thousands per year) and maintenance fees.
· The lease is for a finite period of time. It can often cost a fairly substantial amount of money to extend the lease.
· Not ideal for generational wealth building.
When you own a leasehold property, you essentially own everything that is inside your four walls, but this doesn’t tend to include external structures.
The structural parts of the building, the common parts of the building (think the entrance, hallways, etc) are owned by the freeholder and landlord.
The freeholder is responsible for repairs of said communal parts and for the maintenance and general upkeep of the building.
If any repairs are to be carried out, the costs are usually recoverable through the service charge costs and are billed directly to the leaseholders.
The leaseholders can pitch in together and by the freehold, in which each separate flat owner owns a ‘share of freehold’. This has it’s pros and cons in and of itself:
Pros of Share of Freehold
· It gives you much greater control over things such as the maintenance and upkeep of your building. This removes the possibility of a landlord being unfair with charges, etc.
· If everyone in your building owns a share of the freehold, it should also mean that everyone is emotionally invested in the building to a certain degree.
· You will be able to extend your lease at no extra cost or at a very low cost (such as legal documentation, etc), in comparison to having to pay a large amount to extend the lease if your property was fully leasehold.
Cons of Share of Freehold
· Sometimes, when holding a share of the freehold, it may be difficult to get the other owners of the share of freehold to sign the transfer of the freehold if they want to sell their flat. It is also necessary to obtain identification from each of the owners during the sale for the Land Registry, and this can prove to be a problem if one of the other shareholders is unavailable at the time of sale.
· Tenants who own the share of the freehold may be required to undertake administrative tasks, such as any accounting that needs to be maintained. In this situation, if the tenant doesn’t file up to date records, it could result in a large fine.
· Having to take on the maintenance costs can of course mean that some years will see large costs if a major piece of work or renovation is required.
A freehold property is where you own the property AND the land that the property sits on.
You own the property for as long as you wish as there is no lease on the property.
Pros of Freehold
· You own the property and the land it sits on.
· No annual ground rent or service charges to pay, as you own the property outright.
· The easiest way to own property.
Cons of Freehold
· Typically, they are more expensive than leasehold properties, in the majority of cases.
· You obviously have the sole responsibility to repair and upgrade your property.
· Fully freehold properties are rarer in Central London.
Purchasing a property with a lease/ short leases
A short lease doesn’t technically exist – they are essentially long leases that over time have naturally shortened in length.
However, a ‘short lease’ is the phrase that is used in the industry.
A flat with a short lease may be un-mortgageable because mortgage companies look at what each flat is going to be worth at the end of the term of the lease.
For the leaseholder and any potential purchaser, the value of the lease depreciates faster each year, so the cost to extend the lease gets bigger every single year.
On the side of the freeholder, the value essentially goes up each year that the lease runs because after the lease has expired, they get the flat back, or, it costs the leaseholder more money to extend and renew the lease.
When purchasing a short lease, you need to:
· Find out the original term of the lease.
· The original ground rent and how the rent changes over the period of the lease – With 99 year leases, the ground rent tends to double every 33 years, whereas on 125 year leases, the ground rent tends to double every 25 years.
· What is the value of the flat with a ‘short lease’… (The estate agent has already told you this if the flat is on the open market).
· The value of the flat with an extended lease… Look for similar flats in blocks/ buildings. The higher valued properties that are similar in size layout and style, tend to have longer leases.
There are a few things that you need to bear in mind with this process:
· The leaseholder’s notice.
· Costs
· The Valuer
· The solicitor
· Do you qualify for a lease extension? (You must have owned the lease for two years)
· ‘Marriage Value’ (The increase in value of the flat created by the lease extension. It comprises of a combination of the landlord’s/ freeholders interest and the leaseholder’s interest. If you have more than 80 years unexpired, then marriage value is ignored and the extension of the lease is cheaper).
From a freeholder point of view, it is a good thing if the leaseholder takes a long time to extend the lease, as you earn more money.
From the leaseholder’s point of view, it is a good thing if you extend the lease as soon as possible, as it will cost less.
All of the calculations for the price of a lease extension are calculated from when you serve notice.
If you are buying a short lease property, you don’t own it, which means that you can’t serve notice on it (you need to own it for at least 2 years before you can ‘serve notice’ and apply for a lease extension).
The way round this, is to get your solicitor to draw up the section 42 notice (of the leasehold reform housing & urban development act, 1993) with the figures that you want, and you then get the seller to ‘serve it’ upon the landlord and assign the benefit to you.
You should always do this as a condition of exchange so that if the process doesn’t go through to completion, you can get your money back and walk away with all of your money.
A lease extension is valued by:
· Loss of rental income that would occur due to a granted lease extension.
· Loss of ground rent for the original term that would occur due to a granted lease extension.
· Loss of ground rent for the additional 90 years that would occur due to a granted lease extension.
· Changing values for both the freeholder and the leaseholder.
· Compensation to the freeholder as they will not have ownership of the flat for an extra 99/ 125 years.
The general timetable and order for a lease extension is:
· Section 42 Notice is served.
· Counter Notice – the freeholder counters your offer, usually asking for more money. Sometimes, this frightens people away from wanting to extend the lease.
· Negotiate to try to come to a beneficial agreement for both parties – the freeholder and the leaseholder.
· First-tier tribunal (if an agreement hasn’t been arranged).
The most important thing is to read the lease! They are complicated and you should be advised by a solicitor at all times.