Buying A Property With A Short Lease

Buying Property With Short Lease
When purchasing a property, you’re likely to come across the terms freehold and leasehold.

Knowing the difference between freehold and leasehold properties is important, as leasehold can add additional costs to owning a property, affects certain rights over your property, and may affect your ability to obtain a mortgage.

What’s the difference between freehold and leasehold property?

There are two different forms of legal ownership when it comes to property: freehold and leasehold. Freehold means that you own both the home and the land it stands on.

This means that the homeowner is responsible for all repairs, maintenance and costs relating to the property, and may alter the property and use it as they wish.

Leasehold means that you own the building but the land belongs to another person, legally known as the freeholder, but also referred to as the landlord. A contract exists between the leaseholder and freeholder, which sets out certain rights and responsibilities for each party.

The freeholder has responsibilities towards the property, and can have extensive rights too. Flats and shared ownership properties are likely to be leasehold, although there is a growing trend for new build properties to be sold on a leasehold basis.

A leasehold is a long term agreement, usually lasting between 90 and 120 years. However, it can vary enormously. In some cases it may be as much as 999 years, or as short as 40 years.

The rights and responsibilities of leaseholds

Responsibilities Of Leaseholders

The exact rights and responsibilities of leaseholds varies with the property type. When it comes to flats, for example, leaseholders may have to pay an annual fee to the freeholder, known as a ground rent.

This can vary considerably in cost, depending on when the lease was last negotiated. In addition to this, leaseholders may be required to pay maintenance fees and annual service charges, and a portion of the building insurance.

Unless there is a ‘right to manage’ granted to the leaseholder, in the case of flats the freeholder is responsible for maintaining common parts of the building such as the entrance hall and staircases, plus the exterior walls and the roof of the property.

When it comes to both flats and houses, should the leaseholder want to make any substantial alterations to the property, for example, an extension, they will need to obtain permission from the freeholder. There may be other restrictions too, such as whether the leaseholder is allowed pets or whether they may sublet the property.

As can be seen, leasehold is very difference from freehold.

What’s classed as a short lease?

A short lease is one where there are limited years left on the contract. There’s no hard and fast answer to what’s classed as a short lease, but in some cases, anything below 80 years may be considered short. Certainly anything below 50 years would be considered a short lease.

Why are short leases a problem?

Graphs Of Relativity

Short leases are a problem for those seeking to sell their property, as it affects the value of the property.

There are a number of published graphs, known as Graphs of Relativity that shows the impact of various lease lengths on the value of the property. A lease of 60 years will reduce the value of a property by 10% compared to a property with a 99 year lease.

For those looking to buy a property, there can also be problems. Mortgage lenders are reluctant to lend when they consider the lease to be too short.

Where the lease is less than 80 years, it is common for would-be purchasers to insist that the leaseholder extend the lease before they complete the purchase.

What’s the minimum lease for a mortgage?

Lenders will normally want a lease to run for at least 25 years beyond the end of the mortgage. With mortgages typically lasting 25 years, that’s a minimum length of 50 years.

However, in reality, lenders are likely to want a minimum of 80 years left on the lease to guarantee the value of the property they are lending against. 

Can the lease be extended?

While homeowners can ask the freeholder to extend the lease at any time, they usually need to have been a tenant for at least two years.

Once they have owned the property for two years, homeowners have the right to ask to extend the lease by 90 years on a flat, or 50 years on a house, provided that they are a qualifying tenant.

If the original lease was more than 21 years when they purchased the property, the homeowner is usually classed as a qualifying tenant.

The lease may be extended using the terms of the Leasehold Reform, Housing and Urban Development Act 1993, if applicable, or by private negotiation with the landlord.

How much will it cost to extend the lease?

Cost Of Extending A Lease

While there are calculators available, there is no set amount when it comes to extending the leasehold contract. The cost will depend very much on the property and its value, and will be negotiated between the freeholder and the leaseholder.

The way that the cost is calculated is in line with Schedule 13, Part II of the Leasehold Reform, Housing and Urban Development Act 1993.

When calculating the premium, a number of factors are taken into account including:

  • The reduction in the value of the landlord’s interest; i.e. the difference between the value of his interest now and the value of his interest after the granting of the additional 90 years on the new lease, as the entire new lease will be at ‘peppercorn rent’ (no ground rent payable).
  • The landlord’s share of the ‘marriage value’, defined below, if the current lease has less than 80 years left.
  • Compensation for loss arising from the granting of the new lease.

Reduction of the landlord’s interest

The reduction of the value of the landlord’s interest is considered to be the loss of income arising from the loss of ground rent for the remainder of the original term, and the loss due to the additional 90 years wait to take legal possession of the property.

Marriage value

Marriage value is calculated as the potential for increase in the value of the flat that occurs as the result of the granting as the new lease. As already discussed the remaining length of the lease can have a considerable effect upon the value of the affected property.

The above mentioned Act lays out that any profit must be split equally between landlord and leaseholder. This potential profit is calculated using the knowledge and experience of valuers from the local area to assess the probable increase in value.

Compensation

It is unlikely that the landlord will be granted compensation, as they will retain the freehold. One potential reason that they might be able to claim compensation is if there was the potential for redevelopment of the land, which they have now lost.

Reaching an agreement

Agreeing A Lease Extension

There is no requirement for a formal valuation of the property to be obtained, but it would be sensible for both parties to seek their own valuation. If both parties are happy to do so, then an agreement can be reached informally.

However, if this is impossible, then there is a formal procedure, which begins when the leaseholder makes an offer in the form of a Tenant’s Notice. This does not need to be the same as the valuation, and the tenant is not legally required to disclose any valuation. 

If the landlord is not happy with the offer made, they may make a Counter-Notice with their own asking price.

Tribunal decisions

Ideally, the two parties will negotiate a premium between them. However, if they are unable to reach an agreement, they may make an application to the First-tier Tribunal (Property Chamber) within prescribed timescales. This tribunal will listen to both parties and determine all of the above issues relating to the premium.

For leaseholders it’s worth noting that stamp duty is applicable if the premium is over £125,000, as it would when purchasing a property to live in.

The leaseholder is also liable for their own and landlord’s reasonable professional costs. These can be significant and, at a minimum, are likely to include solicitors and surveyors.

Buying the freehold of a leasehold property

A leaseholder has the right to ask the landlord to sell them the freehold at any time, under the Leasehold Reform Act of 1967, if they meet qualifying criteria.

There are different rules and procedures depending on the type of property. If the property is in a block of flats, then you will buy a share of the freehold with the other tenants in the building.

If it is a standalone property, then you may buy the freehold outright. In situations where the landlord wishes to sell the freehold of a block of flats, they are required to offer the leaseholders first refusal.

The sale of the freehold may be performed informally or formally. Where the sale is agreed informally, there is no access to the Tribunal.

However, if the parties opt to follow the formal route, there are procedures and timescales laid out in law that determine the price and terms of the purchase if the two parties are unable to reach an agreement.

Summary

Purchasing a leasehold property raises a number of issues and can incur significant costs compared to buying freehold.

Those seeking to purchase a leasehold property, whether a flat or a house, should familiarise themselves with the potential pitfalls and additional costs before proceeding with the purchase.

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