Why extend your lease

If you are a leaseholder, chances are that at some point you will want to extend your lease. Stewart Gray explains what you need to know.

England and Wales still have a feudal land owning system inherited from the Normans and, as a result, technically all English and Welsh land is owned by the crown. The land on which most property stands is held from the crown using a form of tenure called freehold. This is the nearest thing in law to absolute ownership of land. A freeholder ‘owns’ not only the surface of the land on title but landowner’s rights which extend upwards to the heavens and down to the centre of the earth. When deciding to build a house the freeholder can (with planning permission) build as many storeys as he wishes upwards or downwards and the maintenance of his entire property is his own responsibility. Having built a freehold house the property can be bought and sold with the maintenance responsibility passing along with the ownership in a relatively straightforward manner.

The problem arises when a freehold is divided laterally (into flats for example). If a freehold house is converted into two flats, one above the other, then the two flats cannot each be sold freehold as the ownership rights would clash. The question of maintenance also becomes complicated. Who is to be responsible, for example, for maintaining the roof ? Perhaps the upper flat – but if this is a small studio in a large building such an onerous maintenance obligation would render the studio worthless.

The solution is for the freehold to be retained by one entity who owns the land and is responsible for the maintenance of the commonly held parts of the building. The flats are then given long term leases of 99 years or more which can be sold to independent flat owners. The extent of each flat is described in detail on the lease and each of the flat owners maintains their own property. In addition the leaseholders each pay an agreed share of the freeholder’s service charges. This pre-agreed service charge should (in theory) allow the freeholder to maintain parts of the building not covered by leases without  disputes arising over what share of maintenance should be paid by the various flats each time any work is carried out. (see pages 53-58 of this issue for more on service charges).

From the freeholder’s perspective purchasing a freehold investment can be expensive and building management can be a significant burden. For this reason freeholders expect a healthy return on their investments. This is where the freehold / leasehold system is controversial because the two are linked and a return to the freeholder means a cost to the flat owners. Often the main source of income for freeholders is in lease extensions and it is this element that is often controversial. It is here that the lessee’s interests and those of the freeholder most obviously clash. Beware short leases

What is so often forgotten by flat buyers is that it is just a lease that is being purchased not bricks and mortar. The lease is a diminishing asset and as the term reduces so does the value. The shorter the lease becomes the greater the cost to the leaseholder of extending and the greater the value to the freeholder. For this reason freeholders generally have no incentive to encourage flat owners to extend. Potential buyers of flats and current flat owners must therefore make themselves aware of the length of their own lease and the cost of extending it. As a rule of thumb anything under 80 years is considered ‘short’ but really even if your lease is approaching 85 years you should start to make enquiries. There are two linked problems with a short leases:  Firstly anything under 80 years will be difficult to sell and anything below 70 years might not even qualify for a mortgage, limiting the market drastically. The second problem is the cost of extending, which usually runs into thousands of pounds and increases (sometimes dramatically) as the lease term runs down. The key is to make yourself aware of any potential lease length issue and face up to it early before the cost becomes unaffordable. Fortunately leaseholders do now have rights and there is a wealth of advice available, for example the Leasehold Advisory Service which can be easily accessed online at www.lease-advice.org is an excellent resource.

In the past if a lease had fallen below 80 years the freeholder had flat owners over a barrel. Short lease flats could become virtually un-saleable without a lease extension and the freeholder was free to name his price on extensions or refuse to extend at all while the cost rose inexorably. This was recognised to be inequitable and the Leasehold Reform Act was passed in 1993 giving leaseholders the right to extend their lease for a fair price. Under the same Act groups of leaseholders in blocks of flats were given the right to buy out their freeholder completely by what is known as collective enfranchisement. Collective enfranchisement requires participation by at least 50% of flat owners and there are other eligibility requirements so leaseholders must take professional advice if considering this course. What’s the benefit? The benefit of extending your lease is under the 1993 act is that the entitlement is for an additional 90 years at no ground rent. This means that once extended, flat owners can have the peace of mind that their investment in their own property is secure for a lifetime and the asset is no longer a diminishing one. A flat with a lease extended under the statutory provisions should sell for full market value even if it is held by the leaseholder for a generation. Similarly, collaborating with fellow leaseholders to buy the freeholder out resolves the lease length issue because with the freehold purchase comes the right to extend your individual leases by 999 years at any time. The collective enfranchisement route also has other benefits, particularly if flat owners are in dispute with their freeholders over maintenance (or lack of it). By purchasing the freehold, blocks of flats become effectively co-operatives managing their own affairs in terms of maintenance and insurance and usually make significant savings in the process. In this respect it is similar to the ‘right to manage’ which has more recently been granted to leaseholders but without the limitations. Nor is ‘right to manage’ a remedy for short leases. However if leaseholders are having management issues and do not qualify for enfranchisement, ‘right to manage’ is another alternative to explore.

The Leasehold Reform Act 1993 lays down a formula for establishing the price of extending your lease or buying the freehold but what constitutes a fair price remains hotly contested. Within the set formula (see page? for an example) are a number of variables and while one surveyor might put forward a value favourable to flat-owners another might take a stance more favourable to the freeholder. For this reason both sides should take independent advice. Generally a settlement price is negotiated between the two sides’ valuers. Where no agreement can be reached the First-tier Tribunal (FTT) can determine the price. Often a price can be privately negotiated but valuation advice is essential to ensure that the terms and price of informal deals are equitable while an awareness of the legal process is useful in case they are not.

Stewart Gray from Austin Gray, an East Sussex based property company specialising in lease extensions