Ground Rent Cap (Reform) - Impact on Lease Extensions
The government's proposed changes under the draft Leasehold and Freehold Reform Bill 2024 aim to alter the current methodology used to calculate lease extension premiums. See the full recap of the draft Leasehold and Freehold Reform bill . This article focuses on the planned 0.1% cap on ground rents.
This section of the bill is specifically targeted at those burdened with high ground rents or facing steep increases after future rent reviews, the bill promises to reduce financial strain - but by how much, and is it really worth waiting of these changes?
How the 0.1% ground rent cap might work
If the proposed bill goes through, leaseholders will not automotically get a cap on their ground rent. Instead, when extending their lease, the ground rent will be presumed to be capped at 0.1% of the value of the property. When calculating a lease extension premium, as the ground rent is cancelled to nil (peppercorn), any cap on the future ground rent will result in a lower premium being calculated.
If the ground rent is under 0.1% of the value of the property then this proposed change is irrelevant and has no impact at all. If the ground rent is currently above 0.1% of the flat value (or will be in the future through ground rent reviews) then the ground rent wil be presumed to never exceed that percentage.
Worked example of a capped ground rent lease extension
As an example, take a flat value of £200,000 with 90 years remaining.
Current Law:
- Fixed ground rent: £200pa
- Ground rent compensation = £3,000
With doubling ground rent every 25 years:
- Ground rent: £200pa but doubling every 25 years with the next review being in 1 year
- Ground rent compensation = £6,800
- Ground rent: £200pa but doubling every 25 years with the next review being in 20 years
- Ground rent compensation = £4,200
Proposed Law:
Capped ground rent that would have been doubling every 25 years:
- Ground rent: £200pa but woud have been doubling every 25 years with the next review being in 1 year
- Ground rent compensation = £3,100 - a saving of £3,700
- Ground rent: £200pa but doubling every 25 years with the next review being in 20 years
- Ground rent compensation = £3,000 - a saving of £1,200
It's clear that there is a potential saving on ground rent compensation for leaseholders that extend their leases where their ground rent exceeds (or will exceed) 0.1% of the value of their property. However the time until the next ground rent review has a huge weight on the outcome - the sooner the next ground rent review is, which takes the ground rent over 0.1%, the more saving there will be.
Why capping ground rents isn't a simple science
In certain situations, ground rents are tied to the Retail Price Index (RPI). If the ground rent presently falls below 0.1% of the flat's value, it remains to be clarified at which threshold it is limited to ensure it doesn't surpass 0.1%. The unpredictability of inflation compounds the issue, which seems to have been overlooked by the government.
As property values tend to appreciate over time, it's conceivable that even if ground rents were to double, they may not pace with the escalation in property values or inflation. A ground rent that doubles every 25 years equates to an annual increase of 2.88%, a figure substantially below the growth rate of house prices and inflation over the past quarter-century. Therefore, in some scenarios, the doubling of ground rents could lead to a reduced effective ground rent value for landlords when considering the real purchasing power.