Landlords often buy flats which are either Leasehold or Shared Freehold. What are these tenures and what should landlords look out for in these different forms of ownership?
This article applies primarily to English law. Although tenancy laws are similar in other jurisdictions, there may be significant differences. Always seek professional advice before making or not making important decisions.
Leasehold is one of three forms of tenure (property/land ownership) almost exclusively peculiar to the United Kingdom, though Scotland has a different legal system and few leaseholds. Alternatives are Freehold and Commonhold.
The legal concepts go back to antiquity in a tenure system where, unlike some other countries (USA for example, remember the land grabs) where ownership of land can be outright, the Crown owns all the land in the UK.
Freehold gives the stronger form of tenure, giving outright “ownership” of the land in perpetuity (forever). There is no landlord to answer to: to pay ground rent to, or annual service charges, or to get permission to do alterations.
Leasehold (sometimes known as long-leasehold) gives a time limited form of ownership (a tenancy) but there is a legal right to extend the lease. Especially in cities like London, leasehold ownership houses millions of people. The landlord may be a large property owning estate (The Devonshire Estate for example) which retains the freehold.
Commonhold is a relatively new form of property/land ownership in the UK, introduced in 2002 as an alternative to the long leasehold system. Commonhold is an attempt to bring flat ownership into the 21st century and it’s the equivalent of the US-style Condo (Condominium) system. Despite the innovation, take-up has been minimal.
As a Freeholder (outright owner) you have responsibility for your own property, insuring, repairing and maintaining. If you allow the property to decline and fall down that’s your own affair, you “own” it and the land it stands on.
As a Leaseholder, you are responsible for the internal repair and insuring (your possessions), but not for common areas, and externals such as roofs, drains, walls etc. All this is the freeholder’s (landowner’s) responsibility. Any one leaseholder would not be in a position to do this work; it needs to be organised centrally and for all, but of course it is charged back to each flat leaseholder in the form of service charges.
Service charges vary from block to block as they may involve paying for things like maintaining large communal gardens, electricity bills for communal areas, repair and maintenance of exterior walls, roofs and lifts.
The advantage of normal leaseholds is that the freeholder or his managing agent does all the organising and work to keep the property (the block) up to scratch. No one leaseholder can neglect her flat and devalue the whole building. The disadvantage is that some freeholders are better than others at managing blocks, plus repairs are invariably more expensive than if you were a freeholder doing and making your own decisions, mainly because of all the people involved and their fees.
There are legal safeguards to prevent freeholders overcharging leaseholders or doing sub-standard work, and this can be challenged through the Leasehold Valuation Tribunal. Nevertheless, disputes can prove very expensive to leaseholders as the freeholder’s legal costs in defending an action by leaseholders are usually charged-back to the leaseholders through service charges.
With commonhold, the individual flat owners (i.e. residents) own everything in perpetuity. There’s no landlord, freeholder or lease. The land the building sits on is registered as commonhold land (as opposed to freehold land), and each flat owner (unit owner) has two distinct legal interests:
(1) in his own individual flat, and (2) a collective interest as a member of a Commonhold Association (in effect a residents association), which owns the land and manages the shared parts of the property on behalf of all the residents. In the UK, commonhold ownership hasn’t really taken off since the 2002 Leasehold Reform Act introduced it, so commonhold is not so common in the UK.
Developers of blocks of flats like to retain ownership as freeholders through leaseholds, which gives them a long-term income through ground rents, and other fees when people renew leases and make alterations. There is therefore no incentive for the UK developer to sell on as a commonhold.
With Leaseholds there are two other aspects or forms of sub-ownership: shared management and shared freehold.
With shared management (Right to Manage) the leaseholders club together, form a management company, and run the block as a leaseholder management committee in their own company. The Right to Manage legislation lets leaseholders take over certain management tasks from the landlord without having to prove bad management. Leaseholders have a right to manage only when certain strict conditions are met – see Leasehold Reform Act 2002.
Leaseholders can buy a share of the freehold with the other leaseholders (such as other people living in a small block of flats) as long as at least half of them agree to buy a share, but if there are commercial parts (a ground floor retail premises for example) this complicates matters considerably.
With shared or “share of” freehold there are two basic set-ups for the ownership of the freehold: (1) the freehold is owned jointly by a number (up to four) of the flat owners in their personal names, and (2) a company is the owner of the freehold and each of the tenants hold a share or membership in that company – they are directors of the company.
Leaseholders therefore, in obtaining a share in the freehold, their name will either be noted on the title deeds or will be issued as a share in the company that owns the freehold. In either case shared freeholders will own a share in the freehold.
Implications of Leasehold
As a leaseholder you have a lease from the freeholder (sometimes called the landlord) to use for a specific number of years. Leases commonly give 90 years, 12o or 150 years, but less common in London, can be as long as 999 years – known as a virtual freehold. Every leaseholder has a contract (lease agreement) with the freeholder, which sets down the legal rights and responsibilities of either side
The value of a lease starts diminishing from the day it is signed, year by year until it runs out at year zero when, if not renewed, the freeholder takes back ownership. Leaseholders can extend a lease at any time and have a legal right to do so. This should be done before a lease reaches 80 years as the value of the lease will diminish rapidly and the cost of extension increases inexorably below this point. That’s because most mortgage companies will not lend below 80 years or absolute minimum 70 years. Lenders will normally want the lease to run for 25 to 30 years beyond the end of a mortgage.
When buying a leasehold property always have an expert look over the small print of the lease document. Make sure that no one leaseholder can start legal actions against the freeholder, for which you are liable to pay for through service charges. This is just one aspect that can prove to be a liability.
Implications – Share of Freehold
Agents usually sell “share of freehold” as a positive, and in most cases it is. A straightforward lease is a wasting asset and becomes less valuable as it gets shorter. Eventually you will need to extend the lease, but normally if you have a share of freehold you will not be required to pay for this. It is therefore cheap and easy to achieve. This can be a significant saving. For example to extend a lease gone down to around 70 years for a £400,000 flat could be anything around £25,000 and upwards, paid to an independent landlord.
Make sure there is a proper management system in place for repairs and that there are no problems or disputes between the tenants before you buy.
In the case of leaseholds, a good freeholder or managing agent will manage professionally and will save the leaseholders having the responsibility for keeping the block well maintained. However, this is rarely cheap and can be very costly in terms of poor maintenance or high fees or both if your block manager is bad.
Shared freehold is more common in small blocks where there will be obligations on the tenants to manage: filing accounts, annual returns for the freehold company, arranging tenant meetings and organising insurance and repairs.
Proper maintenance needs to be planned on an annual basis, but sometimes major works are required in any one year. This can cause volatility in the amount of service charges due, so to counter this effect a sort of saving-up, sinking or reserve fund can be set up which is paid in to each year.
Generally these types of arrangements are put in place where there is a professional managing agent running the block, usual for large blocks with multiple leaseholders or a sharing of freehold. But for smaller blocks the administration costs charged by a management agent may be out of proportion and too expensive.
Where a freehold is owned jointly in the personal names of the tenants, difficulties can arise in getting agreement on permissions for alterations / extensions and to get the other owner/s to sign a transfer of the freehold of the flat if it is to be sold. The Land Registry will require identification from each owner which can also cause further problems on transfers. Generally though, shared ownership advantages outweigh their disadvantages and share-of-freehold ownership helps the marketability of a flat.LandlordZONE® Forums