Residential Ground Rents
Residential ground rents are created when long-leasehold interests are sold by the freeholder.
Typically this occurs when self-contained apartments are built, and then sold on a fixed-length lease with an annual ground rent payable to the freeholder.
Active Market in Ground Rent Investments
There is an active market for these freehold ground rent interests, which date back to the early 20th Century when large landowners would lease their land to speculative builders.
This explains the large amount of houses on 999 year leases around Bristol, Sheffield and Manchester, with the original freeholders often local farmers or religious organisations with large landowners.
Nowadays they are more likely to be held by specialised ground rent investors as long-term reversionary investments.
Reversionary investments are log-term in nature and usually involve the purchase of a property with a long-term tenant in place (usually Regulated Tenancies, sometimes known as Rent Act sitting tenants), or alternative the purchase of the freehold of a property with a long-leaseholder in place.
Sooner or later the sitting tenant either dies or leaves, or the long-lease expires or is renewed.
The long-leases therefore are commonly known as ground rent investments, and these occur when all the apartments within a property block have been sold on long-leases.
The individual leases usually oblige the lease-holder to pay a low annual charge (ground rent) that provides a source of income to the Freeholder.
This in itself is too low to make the investment worthwhile in the short-term, but the accumulative income of all the apartments in the block, together with the reversionary interest (the right to receive the apartments back when the leases eventually expire), provides the Freeholder with an additional return to his investment.
Increasing Demand for Ground Rent Investments
The demand for ground rent investments has grown in recent years and the auction houses have been offering more of these for sale. Generally these are affordable investments which are capable of providing a secure return along with the other means of returns including reversions, lease extensions, insurance and management fees and fees for changes and developments.
What is the Value of Ground Rents
There are several variables with affect the value of a ground rents and some experience is needed to fully understand and appreciate all the potentialities and the investment risks involved:
- The length of lease time remaining on the individual flat leases – term or time to reversion.
- The annual ground rent charge paid by the individual leaseholders and the total amount received from the block.
- Increases in the ground rent charge – for example, charge doubles every 25 years, or is increased in-line with the Retail Price Index (RPI).
- The general condition of the building, any potential problems such as structure, subsidence, or tree growth, the area it’s in, and the likely hood of any debts or difficulties with ground rent collection.
- Whether or not there are ancillary services provided by the landlord, for example, insurance, management or provision of car parking.
- Complexities and therefore potential problems with the drafting of the individual leases.
The Ideal would be:
- Shorter leases, with a maximum of 125 years but preferably less than 99 years.
- Ground rents which rise at regular intervals – e.g. with RPI every 25 years.
- Smaller number of, but higher value leaseholders.
- The landlord to arrange insurance and management.
- Well drafted leases making the maintenance responsibilities clear, with no room for ambiguity.
The Ground Rent Market
The ground rent market is largely an interaction between residential developers and long-term ground rent investors.
Developers typically sell to free-up funds to invest in future land purchases, they often find they are able to deploy the funds more efficiently purchasing speculative sites for new buildings.
The extensive administration involved in issuing ground rent demands also plays a part in decisions to sell. Owners of a small numbers of ground rents do not benefit from the economies of scale afforded to large owners.
Legal implications also play a part in vendor’s decisions to sell, often the subject ground rents are the last remaining asset of the special purpose vehicle formed to carry out the development.
Criteria for Investment in Ground Rents
Investors in ground rents look at several criteria when assessing the suitability of purchasing a freehold to add to their portfolio.
There are two main strategies for returns with ground rent investments:
- The reversion, where the lease lengths are relatively short (60 to 125 years). Where a lease is less than 60 years the lease-holder would need to extend before a sale as finance is almost impossible to secure on lease lengths of less than 60 years
- Income, where the lease length is longer but annual income is higher, or where payments increase a intervals of several years.
The passing income is significant, as is the structure of any future rental increases. The upkeep (management) of a block is important, as is the ‘fit’ within the investors existing portfolio.
Well drafted occupational leases are important, the ability to recover outgoings and arrears from long-leaseholder’s is important in order to protect the value of a landlord’s investment.
Legal Structure of Ground Rent Investments
There is an extensive legal framework involved in the ground rent sale process, with the long-leaseholders having the right to pre-empt a sale to a third party.
This is effected by the Section V notice (s5), which it is the responsibility of the parties to the transaction to serve at least two months prior to any exchange of contracts or undertaking for sale.
Most experienced ground rent purchasers will handle the service of Section V notices on the vendor’s behalf at no charge.
Pre-contract enquiries are normally limited, but for larger or more historic blocks can be more extensive. For smaller units with low capital values transactions can often proceed to completion with just a few queries and a signed transfer from both parties.
Jeremy Davies is the principal of Elmdon Real Estate LLP, a leading ground rent investor. He can be contacted on 0800 015 2500 or firstname.lastname@example.org . More information on Elmdon Real Estate LLP is available at www.elmdonrealestate.com