Buying a flat with a share of freehold usually means that, as well as a long lease, the purchaser will receive a share in the landlord company. This is often marketed as a huge benefit. But that is not always the case.
Tenants with a share of the freehold collectively manage their own building and should be able to ensure that it is done properly and efficiently. Having only their own interests at heart, tenants should be able to focus on carrying out only those works which are reasonably necessary, at competitive prices, keeping service charges transparent and affordable.
When compared to a block managed at arm’s length by a third party landlord, the benefits of a tenant-run building seem clear. The tenants will have no broader reputation to maintain, favoured contractors to promote or profit margins to aim for on sale. Furthermore, if their flat leases are relatively short, tenants can agree between themselves to extend their leases for little or no additional cost, avoiding the costly and time consuming statutory process but increasing the value of their flats at the same time.
So, in theory, tenant-run developments seem to tick all the boxes. But what about in practice?
There are many examples of tenant-managed blocks which function very effectively. In my experience, these are often smaller blocks of flats with relatively like-minded tenants. A colleague, for example, lives in a relatively recent conversion containing six flats, the majority of which are owner occupied. Three of the tenants are directors, two of whom happen to be lawyers and the other a property developer. Works are paid for on an ad hoc basis but essential repairs happen without much issue and communication between tenants is frequent and friendly.
However, the responsibilities of managing a block of flats should not be underestimated and it may well be a different story once the current directors in this block sell their flats. Where managing agents are not appointed, the duties of the directors will involve deciding on a programme of works, costing it, collecting the service charge and dealing with any issues arising. In addition, buildings insurance will need to be organised and paid for and all statutory consultation procedures and company filing requirements met.
Another example illustrates the potential pitfalls of a tenant-managed block of flats. A dispute arose regarding proposed works to the building and one of the tenants refused to pay his share of the service charge. This meant that the work was not done, as the company had no assets or capital reserves with which either to make up the shortfall or to enforce the payment. As a result, window frames became rotten. Since this was essentially a result of the landlord company failing to carry out its duties, the cost of replacing the windows was not recoverable via the service charge and the directors had no choice but to stump up the money.
As freehold companies own only one property, on a not-for-profit basis, any large expenditure which is not covered by the service charge can render it insolvent. Similarly, failing to file company accounts on time can lead to the company being struck off the register and the freehold passing to the Crown. A purchase of a flat in a building where this had occurred was recently substantially delayed while the freehold company was restored to the register – an expensive and time consuming process which must be applied for within a specific period of time to avoid the company being completely dissolved.
Having a share of freehold should in theory mean that the tenants are more in charge of their own financial destiny. Third party landlords are often seen as having little interest in how their buildings are run and little concern over affordability. Putting the management responsibilities into the hands of the tenants should reverse this position.
Tenant run buildings should, however, be approached with an element of caution, especially if individuals are reluctant to become actively involved in the management of the block. The responsibilities of directors of freehold companies can be huge and it is therefore often worth the tenants appointing managing agents, despite the additional cost. Any disputes or other management issues will have to be disclosed to prospective purchasers and can have an adverse affect on both the resale value and the marketability of the flat.
Although generally given a very positive spin in the market, the words “share of freehold” should instead invite careful scrutiny of how the management works in practice before committing to the purchase.
Olivia Tassell is a partner at law firm Boodle Hatfield.
