Freehold and leasehold ownership in UK

Freehold and leasehold ownership

What does “ownership” mean? When an estate agent markets a house or flat as being “for sale”, what is the asset on offer? In England and Wales, property is almost always owned on either a freehold or a leasehold basis.

• (1) Freehold is ownership that lasts forever, and generally gives fairly extensive control of the property.
• (2) Leasehold provides time-limited ownership (for example, a 99-year lease), and control of the property is shared with, and limited by, the freehold owner (that is, the landlord).

So we refer to “buying” or “owning” a house or a flat. But when we buy on a leasehold basis, we are in fact buying a lease of a house or flat for a certain number of years (after which the assumption is that the property reverts to the landlord). A leasehold interest is therefore often referred to as a wasting asset: while it may increase in value in line with property prices, its value also tends to fall over time as its length (the “unexpired term”) reduces. There comes a point when the remaining length of the lease makes it difficult to sell, because purchasers cannot obtain a mortgage since lenders will not provide a mortgage for the purchase of a short lease.

In addition, leasehold owners often do not have the same control over their home as a freehold owner. For example, they may not be able to make alterations to their home, or choose which type of flooring to have, without obtaining the permission of their landlord. The balance of power between leasehold owners and their landlord is governed by the terms of the lease and by legislation. Recently, concerns have been raised that the lack of control historically associated with leasehold ownership has – in some cases – become a feature of freehold ownership. We return to that issue below.

As well as a division of control, landlords may have different interests from leaseholders. For instance, the landlord may see a leasehold property solely as an investment opportunity or a way of generating income, while for leaseholders the property may be their home as well as a capital investment.Different types of ownershipFreeholdLeaseholdDuration of ownershipLasts foreverTime-limitedControlGenerally extensiveShared with landlord

In summary, therefore, leasehold does not provide outright ownership. The experience of leasehold owners has been described as being that of “owners yet tenants”. On the one hand, they are homeowners, with some of the benefits that ownership brings, such as a financial stake in the home. On the other hand, they have a landlord who maintains some control over their use of their home, who has a financial interest in their home, and who will ultimately take back the home on the expiry of the lease.

The inherent features of leasehold “provided the impetus for the development of commonhold, and remain at the heart of many criticisms of leasehold. They do not simply suggest the need for tighter regulation of developers and landlords in the interests of their leaseholders. Instead, they call into question the ability of the landlord-tenant relationship to deliver home-ownership, and provide an imperative for a radical increase in the control held by individuals over their homes. This change, which is reflected in the Law Commission’s three residential leasehold and commonhold projects, arguably marks a renewed focus on the home as a vital element in people’s financial and personal autonomy”.¹¹

Leasehold as a valuable asset for landlords

As we go on to explain below, these inherent features of leasehold ownership are the root cause of many criticisms that have been levelled at it as a mechanism to deliver home ownership. Conversely, these features of leasehold ownership are the very reason that it is an attractive investment opportunity, and a valuable asset, for landlords.

(1) Since a lease is a time-limited interest, there will come a point when the leaseholder needs to extend the lease or buy the freehold in order to retain the property. The leaseholder has to pay the landlord in order to do so. In addition, throughout the term of the lease, the leaseholder will usually have to pay ground rent to the landlord, which provides a source of income for landlords.

(2) The landlord’s control over the property provides a further source of income. For example:

• (a) landlords can charge leaseholders a fee for certain actions, such as giving consent to alterations to a flat, or for registering a change of ownership when a leaseholder sells his or her flat; and
• (b) landlords can receive income indirectly through the service charge that leaseholders are required to pay for the costs of maintaining their block or estate. For example, the premium for insuring a block will be paid by the leaseholders, but when arranging the insurance policy the landlord might receive a commission from the insurance company. Similarly, the landlord might arrange for the services at a block (such as for management, for cleaning, or for repair work) to be undertaken by an associated company.

Why are homes owned on a leasehold basis?

Flats

Flats are almost universally owned on a leasehold, as opposed to freehold, basis. There is a good legal reason for that: certain obligations to pay money or perform an action in relation to a property (such as to repair a wall or a roof) cannot legally be passed to future owners of freehold property. These obligations are especially important for the effective management of blocks of flats. For instance, it is necessary that all flat owners can be required to pay towards the costs of maintaining the block, which is important since flats are structurally interdependent. There are therefore good reasons, under the current law, why flats are sold on a leasehold basis.

Houses

• But leasehold ownership is not limited to flats. Sometimes houses are sold on a leasehold basis. That has been the case for some years.More recently there has been an increase in new-build houses being sold on a leasehold basis. That allows developers to sell the property subject to an ongoing obligation to pay a ground rent.
• The legal reasons for selling houses on a leasehold basis are less apparent than those for leasehold flats. One reason might be the need to impose positive obligations on house owners in relation to the upkeep (management) of an estate, but that does not apply in all cases.

A source of income

We have explained that there can be good legal reasons why homes are sold on a leasehold basis. The reasons why, for legal purposes, houses and flats may be sold on a long lease do not, however, require the lease to provide income streams to the landlord , beyond those needed to maintain the property, the block, or the estate.

Leasehold and feudalism

Leasehold is often referred to as “feudal”. In fact, leasehold developed outside of the main feudal tenures and later in time. Leases began as contracts, not interests in land. But while “feudal” is a misdescription of the landlord-tenant relationship, it is not necessarily a mischaracterisation. The language of “feudalism” reflects the power imbalance experienced by leaseholders, and concerns that the tenure has too readily facilitated the extraction of excessive monetary payments from those leaseholders.

What is wrong with leasehold home ownership?

Residential leasehold has, for some time, been hitting the headlines and is the subject of an increasingly prominent policy debate. There is a growing political consensus that leasehold tenure is not a satisfactory way of owning residential property.

“too often leaseholders, particularly in new-build properties, have been treated by developers, freeholders and managing agents, not as homeowners or customers, but as a source of steady profit. The balance of power in existing leases, legislation and public policy is too heavily weighted against leaseholders, and this must change”. Housing, Communities and Local Government Select Committee

Criticisms based on leasehold ownership being inherently unfair

• Many people have a fundamental objection to leasehold being used as a mechanism for delivering home ownership. They argue that the fact that external investors have a financial stake in a person’s home – which arises from the time-limited nature of the leaseholder’s interest and the control enjoyed by the landlord – creates an inappropriate, unbalanced and inherently unfair starting point for home ownership. Leasehold, it is argued, is fundamentally flawed as a mechanism to deliver the type of home ownership that people want and expect. The solution is said to be for home ownership – of both houses and flats – to be delivered through freehold (including commonhold) ownership.
• Arguments about inherent unfairness are compounded by the inequality of arms that exists, broadly speaking, between leaseholders and landlords in the current leasehold regime. It is a systemic inequality between leaseholders (as a whole) and landlords (as a whole), as opposed to an individual inequality as between particular people within those groups. We discussed the inequality of arms, the opposing views on whether leasehold ownership is inherently unfair, and competing arguments about reform in our earlier report on valuation in enfranchisement.

Criticisms of ways in which the leasehold market operates

While there is a strong voice that leasehold is inherently unfair and should be replaced with freehold (including commonhold), there are also criticisms of specific aspects of how the leasehold market operates.To those who have a fundamental objection to leasehold, they are all symptoms of what they consider to be an inherently unfair system. But these criticisms are not made solely by those who have a fundamental objection to leasehold; many who do not object to the use of leasehold nevertheless have concerns about aspects of the way that it operates. For example, concerns have been raised about:

(1) legal, practical and financial obstacles for leaseholders seeking to exercise their statutory rights, including:

• (a) their right to extend their lease or buy their freehold (that is, their enfranchisement rights);
• (b) their right to take over management of their block (that is, the RTM);
• (c) their right to challenge the reasonableness of service charges that have been levied by landlords;

• (d) the “right of first refusal”, which is intended to allow leaseholders whose landlord proposes to sell the freehold of their block of flats to step in to the purchaser’s shoes and themselves purchase the freehold instead;
• (e) the right to apply to the Tribunal for a manager to be appointed to manage the block instead of the landlord;
• (f) the right to form a recognised tenants’ association, and acquire the contact details of the leaseholders in a block in order to do so;

• (2) high and escalating onerous ground rents, with a particular concern about the imposition of ground rents which double at periodic intervals (generally ten years) during the term of a lease; such obligations can make properties unmortgageable and unsaleable, trapping the owners in their homes;
• (3) houses being sold on a leasehold, as opposed to freehold, basis, for no apparent reason other than for developers to extract a profit from owning the freehold;
• (4) the absence of any compulsory regulation of managing agents, either in terms of their qualifications or the quality of their work;
• (5) excessive service charges levied by landlords;
• (6) the ability of landlords to require leaseholders to pay all or some of the landlord’s legal costs when there has been a dispute between the parties, including in cases where the leaseholder has “won” a legal challenge against their landlord;
• (7) the legal entitlement of landlords to “forfeit” (that is, terminate) a lease if the leaseholder breaches a term of the lease;
• (8) the charging by landlords of unreasonable permission fees for leaseholders to carry out alterations to their property; and
• (9) close relationships between property developers and particular conveyancers which may threaten the latter’s independence in advising clients seeking to buy leasehold properties from the referring developers.
• The concerns set out above lie against a background, generally speaking, of leasehold purchasers not understanding what leasehold ownership involves.

“For most consumers, buying a house or flat will be their largest purchase and investment. Because it is a relatively infrequent purchase consumers are unlikely to accumulate significant knowledge of the process or of the salient characteristics of different forms of property ownership. Further, while the value of the purchase may make the consumer cautious, the sheer magnitude of the purchase price will typically make other amounts of money involved seem insignificant by comparison”.

• Further, even when purchasers do understand what leasehold ownership involves, there is often no choice over the form of ownership. As we explained above, flats are almost invariably owned on a leasehold basis.
• Some criticisms outlined above can fairly be described as abusive practices by landlords or developers. The Competition and Markets Authority (“CMA”) launched an investigation into leasehold home ownership in 2019 and published an interim report in 2020. The CMA expressed concerns about ground rents in leases, about misselling of leasehold houses, about service charges and permission fees, and about a failure of “checks and balances” in the leasehold system. The CMA stated that it intended to take enforcement action in relation to the mis-selling of leasehold property, and in relation to leases containing high and escalating ground rents.
• While there have been abusive practices in leasehold, we would emphasise that there are other landlords who operate fairly and transparently. But however fairly the system is operated, inherent limitations of leasehold remain.
• All of the criticisms summarised above derive, at least to some extent, from those inherent limitations – namely that the asset is time-limited, and that control is shared with the landlord. Those limitations are compounded by the fact that the landlord and leaseholder have opposing financial interests – generally speaking, any financial gain for the landlord will be at the expense of the leaseholder, and vice versa. Accordingly, the leasehold system has been reformed over the years in an attempt to create an appropriate balance between those competing interests. Given their opposing interests, it is very unlikely that leaseholders and landlords will agree that the balance that has been struck between their respective interests is fair. Their interests are diametrically opposed, and consensus will be impossible to achieve.

“For landlords, property is fundamentally about money: both the capital value in the freehold and the income that is generated from ground rent payments, commissions, enfranchisement premiums and other fees. That is not to say that the profit generated cannot be used for good ends, and landlords come in many guises. … But the fact remains that the primary value of property to many landlords is financial. And whether a particular landlord has observed better or worse practices does not alter the fact that, systematically, leaseholders still lack autonomy and control over their homes.

For homeowners, the home is also about money, but in a very different sense. It is about having a financial stake in the property in which we live; a stake we are increasingly being asked to draw upon to support us financially into retirement, as well as to support the next generation. But the more a person’s home is used as a financial asset to benefit their landlord, the less it is an investment for the individual. The more a leaseholder’s money is providing an investment for their landlord, the less their money is providing an investment for their own future, their family and their next generation.

For homeowners, however, the home is about more than money. Britain has famously been described as a nation of homeowners. Fulfilling the dream of home-ownership has long been many people’s ambition. Much of this ambition can be attributed to the non-financial, “x-factor” values that home-ownership encompasses, and which have become embedded in an ideology of home ownership. Our home is the focal point of our private and family lives; it is integral to our identity, reflecting who we are and the community we belong to. Bad law and bad practice that affect people’s experience in their home therefore have a particular impact on them. The current programme of law reform marks an opportunity to reform the law so that it can better deliver both the financial and non-financial benefits of home ownership”.

Freehold ownership of flats: commonhold

In many countries, leasehold ownership does not exist. Instead, forms of “strata” or “condominium” title are used so that flats can be owned on a freehold basis.

In England and Wales, commonhold was introduced as an alternative to leasehold in 2002, to enable the freehold ownership of flats. Commonhold allows the residents of a building to own the freehold of their individual flat (called a “unit”) and to manage (or appoint someone to manage) the shared areas through a company. For many blocks, the homeowners would not themselves carry out the day-to-day management but would instead appoint agents to manage the block. Crucially, however, the homeowners (rather than an external landlord) would control the appointment of those agents.

For homeowners, commonhold offers a number of advantages over leasehold ownership. In particular:

• (1) it allows a person to own a flat forever, with a freehold title – unlike a leasehold interest, which will expire at some point in the future;
• (2) no ground rent is payable;
• (3) it gives the homeowner greater control of their property than leasehold; and
• (4) it is designed to regulate the relationship between a group of people whose interests are broadly aligned. That is in stark contrast to the leasehold regime, which has to attempt to balance and regulate the competing interests of landlord and leaseholder.
• Despite these apparent advantages, however, commonhold has not taken off – fewer than 20 commonholds have been created since the commonhold legislation came into force.

Why has commonhold failed?

• Various suggestions have been made as to why commonhold has not taken off.

• (1) Some have suggested that shortcomings in the law governing commonhold can make it unworkable in practice and have led to a lack of confidence in commonhold as a form of ownership.
• (2) Some ascribe commonhold’s low uptake to an unwillingness of mortgage lenders to lend on commonhold units.
• (3) Some think that there may be a lack of consumer and sector-wide awareness of what is a relatively unfamiliar form of ownership.
• (4) Others point out that commonhold remains less attractive to developers than leasehold because of the opportunities that leasehold offers to secure ongoing income-streams on top of the initial purchase price paid by the leaseholders.
• (5) Others point out that Government provided no incentives for developers to use commonhold – and no disincentives to them continuing to use leasehold (for example, by removing the financial advantages for developers of selling leasehold flats).
• (6) Others suggest that the low uptake is more the result of inertia among professionals and developers. Moreover, we have been told that there is insufficient incentive (financial or otherwise) for developers of homes and commercial property to change their practices and adopt a whole new system while the existing one (from their perspective at least) does the job.

Stewardship and culture change

A common thread that runs through all three of our projects is moving management and control from a third-party landlord to homeowners. But it is in relation to commonhold that the management of land has come under the greatest scrutiny, because of the removal of the relationship of landlord and tenant. This shift from leasehold to freehold tenure has raised questions as to the stewardship of land and the utility of the landlord-tenant relationship in the residential context. Stewardship is not always defined, but in this context, we use the term to mean the management of land over time and for the next generation of owners. It has been suggested that landlords are necessary to provide stewardship over residential property. Institutional landlords are said to act as custodians who take a long-term view of the investments needed in a building or estate. Such landlords are also said to have superior expertise in overseeing insurance, maintenance, health and safety, fire risks, planning obligations, building regulations and anti-social behaviour.

But this argument must address the following challenge: if owners of houses are trusted to be the stewards of their house, why can owners of flats not be similarly trusted? While leaseholders have a shorter-term interest than their landlords, it is the term of the lease granted by the landlord that so constrains them. There is no reason to assume that leaseholders would not have the same incentives as landlords presently do if they had the same enduring financial stake. The management of a block is undoubtedly more complex than that of an individual house. It is not suggested that commonhold unit owners themselves will personally take charge. In all but small blocks, where self-management is a realistic choice, the expectation is that professional managers will be appointed.

This insistence on the necessity of landlord freeholders to provide inter-generational stewardship of a building or estate is symptomatic of a broader issue. The reform of leasehold, and particularly the reinvigoration of commonhold, bring about a need for cultural change, and for all participants in the housing market to re-think fundamental assumptions on which the market currently operates.

It has been suggested, for example, that developers will not build unless there is a professional landlord in place to manage the development. This ignores the fact that commonhold structures are used around the world and that large, mixed-use developments are built in those jurisdictions. It is also argued that commonhold owners will not take an active interest in the management of their block. Such arguments operate on the assumption that flat owners are ultimately apathetic about how their buildings or estates are run.While commonhold is about empowering and giving responsibility to owners of flats, it is also about owners of flats being ready to accept responsibility and therefore being ready to take on that cultural change. Law reform must be matched by changes in people’s expectations of what homeownership will involve. It should not be assumed that apathy generated in a leasehold system – where the long-term financial investment and control of a building lie with an external third party – will carry over into a system in which, from the outset, investment and control lie with the unit owners.

In summary, therefore, commonhold should not be looked at through the lens of leasehold. Commonhold involves a culture change. It moves away from an “us and them” mindset, towards “us and ourselves”.

Refer: Reinvigorating commonhold: the alternative to leasehold ownership [2020] EWLC 394 (July 2020)