Following new claims made by a number of leasehold specialist companies, lessees of thousands of newly-built leasehold flats, marketed as ‘virtual freehold’ properties with 999-year leases, are in danger of losing their capital investments.
When flat owners purchase a leasehold flat, they are - in essence - purchasing the right to use the land on which that property was built. The freeholder retains ownership of the land and, in turn, owns the fabric of the building itself. As part of their responsibility as leaseholder, property owners are required to pay ground rent to the freeholder in accordance with a clause written into the lease of the property they have purchased.
Through 'virtual freeholds', freeholders exploit these onerous ground rent obligations to make their as lucrative as possible.
The term 'virtual freeholds' implies that, due to the 999-year lease, the owners' investment will be protected indefinitely because there is no need to extend the lease. In comparison to the lease of a regular leasehold property which often only lasts between 99-125 years, prospective property owners are frequently mis-sold the concept that 'virtual freehold' properties are a cheaper alternative to their supposedly outdated counterparts.
Typically, before even a single brick has been laid, property developers sell the freeholds of their buildings to professional ground rent investors. During negotiations, freeholders often request that certain clauses - typically regarding ground rent - are integrated into the terms of the lease to benefit them before they invest their capital; seizing any opportunity to exploit unsuspecting future purchasers and raise more capital for future investments.
For one property on a development in Chatham, Kent - the potential purchaser of which was a client of Regency Leasehold - a clause was written into the lease which would have seen an initial ground rent amount of £250 per annum (p/a) double every 10 years. Although the ground rent costs may cost little initially, they would have grown exponentially over time to the detriment of the potential purchaser. Within the space of a mere 50 years, the ground rent would have risen to an incredible £8,000 p/a: making the property almost impossible to sell as the ground rent due per year becomes disproportionately high and would have discouraged any potential purchasers in the future.
Furthermore, options such as purchasing the freehold - which would normally negate the obligation to make ground rent payments - is, in many cases, not a feasible option for ‘virtual freeholds’. As the cost of the freehold purchase includes compensation to the freeholder for loss of future ground rent – in this case 999 years of future income - the total cost of the 'freehold purchase' would be exorbitant and simply unaffordable!
Flat owners are often unaware of the effects of these ground rent schedules, as the clauses are buried in the small print of their leases and are regularly missed by their solicitors. When purchasing any property - particularly new-builds - solicitors must inform their clients about the implications of such clauses. Failure to do so could result in lessees having a valid claim against them for professional negligence.
Yet, leaseholders who find themselves in possession of a ‘virtual freehold’ property with unfavourable ground rent clauses could be protected by legislation in some cases. For example, if the owner purchased the flat after 1st October 2015, they would be protected by the Consumer Rights Act (2015). This Act protects the lessee if it is proved that the financial implications of the lease term were not fully explained by the freeholder.
In addition, those who purchased prior to 1st October 2015 may also be covered by the Unfair Contract Terms Act (1977) and could be entitled to legal relief if they can prove the lease terms are unfair.
Nevertheless, ground rent clauses are not the only way that freeholders’ are exploiting leaseholders through ‘virtual freeholds’. Freeholders across the United Kingdom are also making huge profits by charging extortionately high service charges. Averaging more than £1,800 per year for new-build properties, the freeholders' right to charge high service charges - in addition to their control over utility supplies and buildings’ insurance - is detrimental to the leaseholders' ability to sell their property in the future.
Unfortunately, freeholders will continue to take advantage of their authority and influence until the legislation that surrounds the hugely flawed leasehold system is reformed. Ultimately, leaseholders should seek expert advice to ensure that they are comprehensively informed in every aspect surrounding the lease when purchasing a property. Despite the allure of purchasing a newly built property, flat owners should be aware of the potential trap that 'virtual freeholds' represent.
Lewis, W. (2016) 'Thousands of flat owners in 'virtual freehold' nightmare', Property Reporter, 17 November [Online]. Available at: http://www.propertyreporter.co.uk/finance/thousands-of-flat-owners-in-virtual-freehold-nightmare.html (Accessed: 17 November 2016).