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The government has been working to introduce reforms to leasehold property that will alter the lease extension process, impacting both leaseholders and freeholders. This article provides an overview of the situation, tracing its evolution and highlighting current developments that BTL landlords should understand.
What Is a Lease Extension?
A lease extension is the process used to prolong the term of an existing lease agreement between a leaseholder and a freeholder. For leaseholders, extending the lease ensures continued ownership and can enhance the property's market value, making it more attractive to potential buyers or mortgage lenders. For freeholders, it represents an opportunity to negotiate terms and receive a premium for the extension. Additionally, a lease extension helps clarify and update outdated lease terms, reducing the risk of disputes between freeholders and leaseholders.
The Current Context Before Reform
Leaseholders had the right to extend their leases under specific conditions, including:
- Eligibility: Leaseholders were required to have owned the property for at least two years before initiating a lease extension.
- Extension Terms: For flats, the statutory extension granted an additional 90 years to the existing lease term.
- Marriage Value: If the lease had less than 80 years remaining, the leaseholder was required to pay a “marriage value”, which is an additional cost reflecting the increase in property value resulting from the lease extension.
The Proposed Reforms
The leasehold system has faced criticism for being outdated and financially burdensome. In response, the government is planning to introduce reforms to improve leaseholder rights and make the process of extending leases more straightforward and cost-effective. The Leasehold and Freehold Reform Act of 2024 received royal assent in May 2024, and the government is working to implement the proposed reforms as quickly as possible. Under the Act, the following changes are proposed:
- Abolition of the Two-Year Ownership Requirement: Leaseholders will no longer need to wait two years after purchasing a property to initiate a lease extension. This change will allow leaseholders to act immediately after purchase if they wish to, facilitating quicker property transactions and financing arrangements. This regulation has been brought into force as of January 2025.
- Standardisation of Lease Extensions: Leaseholders will be able to extend their leases by a standard 990 years, with ground rent set to zero, upon payment of a premium. This reform will provide long-term security for leaseholders and simplify the extension process. This has yet to be implemented.
- Elimination of Marriage Value: The concept of marriage value will be removed from the lease extension premium calculation, reducing the financial burden on leaseholders. This has yet to be implemented.
In addition to these significant changes, the Act will also:
- Ban new leasehold houses (barring certain exceptions).
- Improve transparency in service charges, administration charges and building insurance commissions.
- Extend access to redress schemes for leaseholders where property is managed by the freeholder directly and remove the assumption that leaseholders must pay landlord legal costs when challenging poor practice.
Implications for Freeholders
These reforms have several implications for freeholders, including:
- Financial Considerations: The removal of marriage value may result in lower premiums received for a lease extension, potentially reducing the profitability of holding leasehold properties. Freeholders should reassess the financial projections of their portfolios in light of these proposed changes, factoring in the anticipated decrease in extension premiums.
- Negotiation Dynamics: With the proposed standardisation of lease terms and premiums, freeholders may have less flexibility in negotiations, limiting their ability to adjust terms based on individual circumstances. This shift places greater importance on understanding the statutory guidelines to ensure compliance and optimise outcomes.
The Lease Extension Process
Understanding how the lease extension process works at present is essential for freeholders to manage expectations and obligations effectively:
- Initiation by Leaseholder: The process typically begins when a leaseholder serves a 'Section 42' notice to the freeholder, formally requesting a lease extension and proposing terms, including the premium amount they are willing to pay. This notice must comply with statutory requirements, such as including the leaseholder’s desired extension term and a proposed valuation.
- Freeholder's Response: Upon receiving the notice, the freeholder has 21 days to request evidence of the leaseholder's right to extend the lease, such as proof of ownership and compliance with eligibility requirements. During this period, the freeholder may also choose to conduct a property inspection to assess its condition and gather information for an accurate valuation.
- Negotiation: Both parties will then negotiate the premium and terms of the lease extension, with freeholders often commissioning a professional valuation to support their proposed premium. With the proposed standardised terms, such as the 990-year extension and zero ground rent, negotiations will likely focus more heavily on the premium amount and any additional costs, such as legal and valuation fees.
- Agreement and Execution: Once an agreement is reached, the new lease terms are formally documented in a deed of variation or a new lease, which must be signed by both parties. This step also involves registering the extended lease with HM Land Registry, ensuring that the updated terms are legally binding and protect the interests of both the leaseholder and freeholder. Efficient handling of this stage is essential to finalise the extension and avoid potential legal complications.
Potential Challenges
Regardless of the proposed reforms, certain challenges may still arise. Freeholders should be prepared for the following:
- Valuation Disputes: Determining the premium for the lease extension could lead to disagreements. Engaging qualified surveyors is advisable to facilitate fair valuations.
- Administrative Delays: When the proposed reforms are fully implemented, an increase in lease extension applications could strain administrative resources, potentially leading to delays.
Conclusion
Lease extensions are set to undergo a significant transformation through and following on from the Leasehold and Freehold Reform Act of 2024. While some of its provisions are not yet in force, with government recognising the complexity of achieving such reforms, the commitment is to ensure that the Act is implemented as quickly as possible. For landlords, staying informed about these changes is essential to navigate evolving trends in the property market effectively. By understanding the reforms and their implications, freeholders can also better manage their investments and maintain positive relationships with leaseholders.
FAQs
Q. How would the proposed leasehold reforms affect the calculation of premiums for a lease extension?
A. The proposed reforms would introduce a standardised approach to calculating premiums for a lease extension. The elimination of the marriage value and the introduction of an online calculator aim to make the process more transparent and reduce disputes over valuation.
Q. How would the removal of the two-year ownership requirement impact freeholders?
A. With the removal of the two-year ownership requirement, leaseholders can initiate a lease extension immediately upon acquiring a property. This change may lead to an increase in lease extension requests, and freeholders should be prepared for a higher volume of negotiations and administrative tasks.
Q. How might the proposed abolition of the leasehold system affect freeholders?
A. The government has announced plans to abolish the leasehold system, transitioning to a commonhold model where homeowners collectively own and manage their buildings. This shift could significantly impact freeholders' rights and income streams, necessitating a re-evaluation of their investment strategies.
Q. What are the proposed new regulations regarding ground rent?
A. Under the new reforms, ground rent would be set to zero (or “peppercorn”). This change would eliminate a traditional income stream for freeholders.
Q. How should freeholders prepare for the increased rights granted to leaseholders under the proposed reforms?
A. Freeholders should familiarise themselves with the proposed regulations, including the streamlined lease extension and enfranchisement processes. Staying informed and seeking legal advice will be crucial to adapt to these changes effectively.
Additional Sources:
https://commonslibrary.parliament.uk/leasehold-reform-in-england-and-wales/
https://www.gov.uk/leasehold-property/extending-changing-or-ending-a-lease
https://www.girlings.com/latest/the-leasehold-extension-process
https://mhclgmedia.blog.gov.uk/2024/11/22/leasehold-reforms-to-improve-millions-of-lives/
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