When you own a leasehold, you have the right to occupy that property for a determined period of time and you are called a “leaseholder”. The right of occupancy is principally governed by a legal document called the lease. As a leaseholder, you do not “own” the property or the land and you will have a landlord (also called a freeholder) to whom you will have to pay an annual ground rent. In the UK, the majority of flats (and in some instances houses) are held on leasehold tenure.
Most leases in the UK, when initially granted, are for a considerable period of time, normally between 99 and 999 years. However, it is important to understand that a lease is a “depreciating asset” and its value is diminished over time as the unexpired term reduces. If a lease is allowed to reduce down to zero years, then it becomes worthless and the property reverts back to the landlord.
The fact that a lease is a depreciating asset is generally not a problem where there is a considerable unexpired period (for example over 100 years) remaining on the lease. However, where a lease reduces below 100 years and particularly as it nears 80 years, it starts to be considered “short”, and it will likely cause a problem when trying to mortgage or sell the property. If a lease falls below 80 years it becomes particularly problematic as the cost of extension will increase significantly as what is known as the “marriage value” is taken into account.
Leaseholders are able to deal with a short lease by either exercising their statutory right to extend the lease, or alternatively, entering into negotiations with the freeholder to agree terms for an extension.
So, which is the better approach and what is involved?
A leaseholder may approach their freeholder to try to negotiate terms for a lease extension. A negotiated extension might seem a cheaper and more straightforward approach at face value, but in some instances the terms of a negotiated lease could be more costly and create further problems in future years.
Some of the challenges and pitfalls of negotiated lease extensions are as follows;
- Ground rent – as discussed below, under a statutory extension, ground rent is reduced to zero. Under a negotiated extension, ground rent can be eliminated, reduced, maintained as per the original lease, or increased (with future escalation clauses also built into the new terms). In the majority of instances, a freeholder will seek to increase ground rent as part of a negotiated outcome.
- Premium – many leaseholders who enter into direct negotiations with a freeholder fail to take advice on the amount of premium that should be paid. The calculation of the premium to be paid is complex and requires the expertise of a valuer. Without taking such advice, there is a potential that a leaseholder could end up “paying over the odds”.
- Number of years - as a general rule, the number of years added to a lease under a negotiated extension is less that would be added under a statutory extension. Under a negotiated outcome, the lease is normally extended to 99 or possibly 125 years. Under a statutory extension, 90 years is added to the unexpired lease term.
- Other lease provisions - under a negotiated extension, the freeholder might try to incorporate new provisions or change existing provisions within the lease, frequently to the detriment of the leaseholder. This cannot be done under a statutory extension.
- Fees - Some freeholders ask for an up-front fee before they will consider offering terms or require leaseholders to pay excessive fees to renew their lease.
It should be remembered that a landlord is under no obligation to negotiate a lease extension and in some instances can offer unreasonable and punitive terms.
A leaseholder’s statutory right to extend the lease of a flat is covered by the Leasehold Reform Housing and Urban Development Act 1993. Under the act, qualifying leaseholders (those who have owned the leasehold for more than 2 years and where the original term of the lease was for more than 21 years), have the right to extend their lease on the following terms;
- Ground rent - the ground rent becomes a “peppercorn” i.e. zero. This ground rent cannot be changed over the remaining life of the lease.
- Premium - the amount of premium to be paid will be determined by negotiations between the leaseholders valuer and the freeholder's valuer.
- Number of years - an additional 90 years is added to the unexpired lease term at the date of the lease extension. Therefore, if the lease has 80 years remaining, following completion of a statutory extension the unexpired term becomes 170 years.
- Other lease provisions - all other terms of the lease remain unchanged.
- Fees - The fees that a freeholder can charge for a statutory extension are limited to those for performing a lease valuation and the legal costs for completing the lease extension. The landlord cannot charge a leaseholder for their administrative costs or negotiation time.
The process of a statutory extension
To qualify for a statutory extension the leaseholder must have owned the property for two years and the original lease must have been for a period greater than 21 years. Providing these conditions are met, then a solicitor can be engaged to serve a statutory notice of lease extension under section 42 of the 1993 act. The leaseholder will need to engage a valuer to determine the premium to be offered to the Freeholder. Once a section 42 notice is served, the leaseholder will have to pay a deposit amount - being the greater of 10% of the proposed premium or £250.
Once the freeholder is in receipt of the notice, they have 2 months to serve a counter notice (S45 of the 1993 act) specifying a premium that they determine to be payable.
Generally, at this point, settlement on an agreed premium is the result of a negotiation between the leaseholders and landlords’ respective advisors/valuers. A period of 6 months is allowed for the parties to reach agreement, however, if the parties fail to make progress after a two-month period, either can refer the matter to the First Tier Property Tribunal for its determination of the premium to be paid.
In essence, the choice between a negotiated and statutory extension is not binary. In many instances it may be appropriate to enter into discussions on negotiated terms and, should reasonable terms not be offered, to serve a statutory notice. In many instances, the serving of a statutory notice can result in a freeholder being a little more pragmatic and reasonable in the terms they are willing to negotiate.
Irrespective of whichever route is chosen, the advice is that a leaseholder should engage the services of an appropriately qualified and professional valuer and solicitor prior to agreeing to any terms and conditions.