Philip Askew outlines how to advise buyers of leasehold property on potential pre-completion or future lease extensions, including the complexities where the remaining lease term is less than 80 years
The leasehold title report we prepare as conveyancers must cover a great deal of information, and our advice on service charge accounts, retentions, covenants and so on provides crucial information to our clients when considering their purchase.
One further key piece of advice to provide to clients is that regarding the remaining term of the lease.
Always include a summary of your conclusions to the client regarding the lease term
There are various matters to take into account when assessing how the remaining term of the lease could impact on those clients’ ownership and future re-sale of the property.
This article provides guidance on what to take into consideration, and suggests best practice when preparing the report and explaining potential issues relating to future or pre-completion lease extensions to clients and lenders. Its aim is not to explain how to act in lease extensions, rather how to prepare clients for when a lease extension becomes necessary in the future, and how to advise your clients and their lender that a lease extension may be required before completion of the purchase.
Extending the lease term
At the time of your clients’ purchase of the flat, both from your clients’ and their lender’s perspective, advice must be given on whether, and if so when, an extension to the lease term should be carried out during the clients’ ownership or early on in the mortgage term.
There are two ways to extend the lease term.
The first is by using the procedure set out in the Leasehold Reform, Housing and Urban Development Act 1993 (LRHUDA 1993). This procedure involves the following.
1) The seller serves a notice on the appropriate landlord in the prescribed format, setting out the premium they are offering and the terms of the new lease – usually, simply to add 90 years to the term, reduce ground rent to one peppercorn, and carry out any necessary updating or variations. (The last point allows for updating statutory references, or correcting issues if, for example, the original lease did not include the full extent of the property in the demise.)
2) The landlord serves a counter-notice advising if they accept that the tenant qualifies, and if so, the proposed terms of the new lease.
3) The tenant assigns the benefit of this notice to the buyer, on legal completion. Buyers must be cautioned that, if no counter-notice has been served by completion, the premium offered may be contested by the landlord and surveyor, and legal fees may increase as a result of ongoing negotiations.
Timescales apply to this type of extension.
The second way of extending a lease is by agreement between the tenant and landlord outside the LRHUDA 1993. This is dealt with by deed of surrender and regrant, and the terms and any premium payable can be agreed directly or with surveyor advice.
The premium payable under extensions made under the LRHUDA 1993 is calculated using a specific formula set out in the act. Specialist surveyors must be instructed to calculate the premium and, if the landlord serves a counter-notice challenging the premium offered, the surveyor will also act for the seller (or new owner, if the counter-notice is served post-completion) in negotiations over the premium.
Where the lease term is nearing, or already below, 80 years, careful advice must be given to clients. If the client uses the LRHUDA 1993 procedure once the lease term falls below 80 years, and particularly if the landlord will use only this procedure, the premium will increase sharply.
Under the act, if the lease term is over 80 years at the time of its extension, the ‘marriage value’ – that is, the deemed increase in value of the leasehold interest – is fixed as nil. Once under 80 years, the marriage value will be factored into the premium payable. The amount due as premium will increase significantly as a consequence.
Lease extensions agreed outside this procedure can create lease terms of any length. The terms can be agreed by negotiation, and a premium may be paid, depending on who the landlord is.
The lender’s requirements for the lease term
The requirements of the Council of Mortgage Lenders (CML) are the first port of call when acting for the lender.
Many lenders require a lease term of the term of years of the mortgage, plus 20 or 30 years. Conveyancers must report to the lender where the lease term fails to meet CML requirements. If a lease extension is then made a condition of the offer, and if you, as conveyancer, do not specialise in lease extensions, a specialist must be instructed to ensure the lender’s condition is fulfilled.
Negotiations would be undertaken between the seller and buyer at that time, as to the funding of any premium due, legal costs, and the manner in which the term is extended.
Who the landlord is will impact greatly upon the advice you provide to your clients at the time of their purchase.
Check the freehold title. Is it a commercial landlord, a local authority landlord, or a share-of-freehold situation? Your advice will differ for each type of landlord.
You should also read through the charges register and schedule of notices of leases. If, in the charges register, a number of notices are entered protecting notices under section 42 of the LRHUDA 1993, and in the schedule, you can see entries referencing that act, you will know that the particular landlord will not deal with anything but the statutory procedure. If that is the case, look at the remaining term of the lease for this property, and if it is near or under 80 years, advise the client that the cost of extending the lease could be significant. Explain that they should take valuation advice on extending the lease term.
The commercial landlord
If you are dealing with a commercial landlord who purchased the freehold and manages the building with a financial focus, it is unlikely that they would agree to extend the lease term without a premium being paid. Advise your clients that there will be a financial implication to extending the lease term.
If the lease term does not meet the lender’s requirements, or if it is near or under 80 years, you must ask, as part of your enquiries, if any approach has been made to the landlord as to extending the lease term, and if so, whether any premium has been discussed. If no approach has been made, ask for the approach to be made and wait for a response before exchange of contracts. This will allow you to advise the client fully before they commit to exchange.
If the premium cannot be agreed outside the LRHUDA 1993, or if there is no response, the LRHUDA 1993 procedure may have to be adopted. If your clients plan to sell before the 80-year threshold, you should explain to them that they may be required to extend the lease term at the time of their sale, potentially at their own cost or from the sale proceeds.
The local authority landlord
Local authority landlords will generally only ever adopt the statutory procedure under the LRHUDA 1993. Specialist advice must be recommended to the client if you do not feel comfortable advising upon the cost and procedure. Specialist valuation advice should be sought; the client must factor in the cost before proceeding.
The private landlord
If there is a named individual as landlord, again, ask for details of how much they would ask for as premium to extend the lease term.
Families often pass freehold titles on from generation to generation and, if the current generation has not seen any significant financial benefit, they could potentially look to charge a large sum to extend the lease term. If negotiations fail, the LRHUDA 1993 procedure would have to be used.
The share of freehold situation
Share of freehold has its pros and cons. The lack of regular monthly service charge is seen as a benefit from a monthly budgeting point of view for many, particularly first-time buyers – that is, until a large and costly repair is needed and there is no reserve fund built up to pay for it.
However, it does have a great benefit from a lease extension point of view. Where the co-freeholders, be it individuals or a freehold management company set up by the leaseholders, all get along and manage the building themselves, they will usually agree to grant long new leases, the optimum being 999 years, at no premium, and with peppercorn ground rent.
Where this can be achieved, it is recommended that the new lease be completed and an application for registration submitted before completion. Failing that, a new lease can be granted directly to your clients at completion, but always remember to ensure that compliant plans are used for Land Registry purposes, if the original plan is to be varied, for example to reflect a new layout or to rectify an error in the original plan. You should also obtain undertakings from the seller’s and freeholder’s solicitors to assist with requisitions raised by Land Registry on the application.
Always include a summary of your conclusions to the client regarding the lease term. Even if, with, say, a 155-year remaining term, you conclude that the lease term is satisfactory from a lease extension perspective, this shows the client and your insurers that you have considered the implications.
If the remaining lease term is between 80 and 100 years, and the type of landlord makes a LRHUDA 1993 lease extension procedure a possibility, explain the financial implications and summarise how costs would increase significantly if the lease term falls under 80 years. Speak to the client by phone to check how long they plan on owning the property, and follow up with written advice by email or in your report. If they have mid- to long-term ownership plans, explain that when they sell, if the lease term is then near or under 80 years, they may be asked to extend the lease term at that time, and possibly at their own cost – which could run to five-figure sums – or reduce the sale price to factor in the cost to the buyer of extending the term. Remember that the financial impact to clients if you do not provide full advice could be high – it could, when they come to sell, create a dent in, if not wipe out, any profit the client may have made on the property.
Although this area of law can appear daunting, you can, by providing clear, practical summary advice at the time of purchase and explaining costs implications to your client, earn trust, build future business, and save the client potentially tens of thousands of pounds of the cost of a lease extension premium, either during or at the end of their ownership.