Negotiating with freeholders to get an informal lease extension deal is utter madness for most leaseholders. You can trash the value of your flat with a bargain offer that seems too good to refuse … and for lawyers a quick deal is easy money, with no repercussions (for them).
The late Louie Burns, a former LKP trustee, distils years of experience to provide this grim warning for innocents who think they are playing in a straight game
This is an in-depth look at the real implications of accepting a non-statutory or informal lease extension from your freeholder.
I apologise that some of this information is complicated and may be difficult to follow, but please bear with me: your freeholder will be relying on the likelihood that you won’t understand it. Make sure you prove them wrong!
Non-statutory or informal lease extensions are offered by freeholders when you wish to extend your lease. They are designed, at first glance, to make it look like you are getting a deal!
Nothing could be further from the truth …
I call these informal offers ‘Trojan horse offers’. Just like the wooden horse left behind at Troy by the ancient Greeks, it looks like a gift … but when you look inside, the details can be catastrophic.
In my opinion, this is a fair analogy of a freeholder’s informal offer. Let’s see why.
You decide to extend your lease. If you have owned your flat for two or more years, then you have a legal right to extend your lease by 90 years and reduce the ground rent to zero. The law states that, when you extend your lease (or purchase your freehold), you must compensate your freeholder three different ways:
1 Ground Rent
This is the total amount of ground rent you owe your freeholder for the remaining years of your lease, but calculated in today’s money.
2 Reversion
This is the amount you would have to give your freeholder as a lump sum, so they could invest for the remaining years of your lease (with an equivalent compound interest rate of, say, 5%), that would be worth the value of your flat – with a long lease – today);
3 Marriage Value
This only applies if your lease has fallen below 80 years. If you extend your lease, the value of your flat will rise. The rise in value must be calculated and the total ground rent and reversion due are then subtracted.
Whatever is left is split 50/50 between you and your freeholder.
Here I use actual figures from a recent transaction in which I was involved as a way of clearly demonstrating the real implications of accepting an informal lease extension.
The details of the informal are also real, presented by a large – and in my opinion – immoral, London-based freeholder.
My example is a nice flat in London
• The value of the flat with a long lease of 99 years: £230,000;
• Ground rent of £75.00 per year, doubling every 33 years;
• Current lease length 75 years.The valuer recommends the following:
• Ground rent total: £2,143
• Reversion total: £5,849
• Marriage value total: £1,754Total for lease extension: £9,746
Plus total fees of £3,500TOTAL PRICE £13,250
If you were to extend your lease using your statutory legal right, the lease would then be 165 years with zero ground rent. It would be 85 years before the lease would need extending again, and even then it would be very cheap as there would no longer be a ground rent element to include within the calculation.
The lease length issues of the flat will have been rectified once and for all, and there would be no future value in the flat for your freeholder.
But your freeholder is more than likely to be a ‘professional’ freeholder. Such freeholders buy the freehold of buildings to make as much money as they possibly can from each leasehold flat within it.
They make money in the following ways:
• From immoral licensing fees hidden in the terms of the lease;
• By claiming a commissions they get back from building insurance, which, of course, there is no option but to pay;
• From inflated service charge fees;
• From ground rent paid each year;
• The money you have to pay them for a lease extension.
Extending your lease is the big pay day for freeholders!
If they can fool you into accepting an informal lease extension, it will turn into tens of thousands of pounds for them. If, however, you extend your lease by an additional 90 years and reduce the ground rent to zero, this basically wipes out all the future profit they will receive from your flat.
They really do not want you to do this. They want you to accept their ‘Trojan horse’ informal lease extension deal.
What does an informal lease extension look like?
I would like to state, emphatically, that you do NOT have a legal right to an informal lease extension. Please bear this in mind, as I will return to this many times.
There is another way you can extend your lease and that is by contacting your freeholder directly. Often they will contact you as soon as they are aware of your desire to extend your lease.
Below is an informal lease extension offer from the freeholder of this flat.
Dear Mr and Mrs Naïve
We are happy to offer to extend your lease back up to 99 years for the inclusive price of £10,200 and our total legal and valuation fees will be an additional £1,000 pus VAT.
The ground rent will be £250 a year, doubling every 10 years.
We are not looking to amend your lease in any way, we will only modernise the terms of your lease. We are able to complete this process in two months.
This offer is valid for thirty days from the date on this letter.
Wow! It appears that the freeholder is a nice guy after all!
The total price they are offering is £10,200 plus fees of £1,200 (Total £11,400) saving you £1,850 to extend your lease back up to 99 years!
Ground rent is just £5 per week and they only want to modernise the terms of your lease!
They will complete this whole thing in just three months (instead of 12 months minimum it would take to extend using your statutory rights).
“This is brilliant. Where do I sign?”
STOP!
That’s why I call these informal lease extension offers a Trojan Horse, because the devil is in the detail.
Let’s examine this offer more closely.
The freeholder generally offers to extend your lease back up to 99 years and this seems like more than enough for most flat owners.
However, there is a very real reason freeholders only offer an extension back up to 99 years and that’s because in 17 years or so, someone is going to have to extend the lease of the flat again – which means that the freeholder gets paid to extend the lease again (and again, and again …).
This would not happen if the lease had been extended by the statutory route.
As I will explain later, the details of this informal offer mean that whoever is unfortunate enough to own this flat when the lease needs extending again in 17 years is going to have to pay an absolute fortune for the privilege.
Beware of another freeholder trick.
You may be offered a 125-year lease extension. This might seem like it could be a much better deal for the flat owner, but what they omit to mention is that the 125-year extension starts from when the lease was originally granted.
This does NOT mean a 74-year lease has been extended up to 125 years!
If you are unhappy with this, you have no legal recourse to argue with your freeholder. You do not have a legal right for an informal lease extension – it is a take it or leave it deal.
[LKP has been provided with an example of a young couple who extended their lease in a private informal deal with the landlord, and found that because the extension had been back dated to 1961, they had one year less on the lease than they would have done had they not extended. This is so blatant even the criminal authorities may have to act.]
The future implications of ground rent
£250 a year doubling every ten years does not sound like a lot of money … but it is!
A ground rent schedule like this is considered an onerous ground rent schedule, which could easily affect the future sale sale-ability and value of the flat. This is because the freeholder is going to make money two different ways from this increased ground rent.
Firstly, the extra ground rent they will get before someone extends the lease on the flat again.
If the ground rent is £250 per year, then the freeholder will make £2,500 more than he would have done had the flat owner not used their statutory rights for the next ten years. Then it doubles, then doubles again and again.
That’s not the big money for the freeholder, though.
The big money comes from the fact that any future owner is going to have to extend the lease on the flat again. However, instead of the ground rent being £70 a year as it is now, the ground rent will be £1,000 a year!
So, how much will the freeholder make over the next 24 years because they tricked the flat owner into accepting an informal offer?
• Cost of the lease extension = £10,400
• Legal fees = £1,200
• 10 years @ £250 ground rent = £2,500
• 10 years @ £500 ground rent = £5,000
• 6 years @ £1,000 ground rent = £6,000
• Cost of the lease extension = £76,500
• Plus legal fees @ £2,000 =£2,000Total received by the freeholder over 24 years = £103,600
Compare this with the £13,250 you would have spent to extend the lease for an additional 90 years with zero ground rent forever more.
The initial saving of £1,850 the freeholder waved under your nose has turned into £90,000 profit! Not a bad business being a freeholder, is it?
Just to be very clear – when a freeholder increases the ground rent they make money in two different ways: the actual ground rent they collect each year; and the future value of a lease extension with an onerous ground rent clause.
A future freehold purchase
Another ploy by predatory freeholders is to offer an informal lease extension to flat owners when they know they are going to sell the freehold of the building.
They offer an informal lease extension and you pay them £10,200. A year later they offer to sell you the freehold of your building.
How do you calculate your share of the freehold purchase?
You have to calculate the ground rent and reversion elements I mentioned earlier, but the ground rent is now huge and doubles every ten years. You will end up paying more than £10,200 to purchase your share of the freehold!
Note: If you had extended using your statutory rights there is zero ground rent and no marriage value as your lease is 165 years, so the only calculation is reversion, but this is over 165 years.
It would cost you about £250 to buy your share of the freehold!
There are many – and significantly worse – offers you will need to be aware of with ground rent.
Here are examples of some I see every day.
Onerous Ground Rent clauses
RPI
Freeholders will often ask for £250 p.a. year rent, doubling every ten years linked to Retail Price Index (RPI). RPI is used to measure inflation and, obviously, no one knows what inflation will be in the future but one thing is for – it will cost you dearly.
Not only will your ground rent double in ten years, but someone will calculate what has happened to RPI over the last ten years and add it to your doubled ground rent!
Capital Value of flat
Freeholders will often ask for £250 a year rent, doubling every ten years linked to 0.025% of the capital value of your flat.
After ten years, not only will your ground rent double, but also your ground rent will then be linked to the actual value of your property!
Capital Value of the estate
Some of the estates in London have ground rent doubling every 10 years linked to 0.025% of the capital value of the estate, not just your flat!
Doubling every five years
I see more and more freeholders trying to fool people into signing informal deals where the ground rent doubles every five years. This is just ridiculously onerous!
Taking any of these deals could leave you owning a flat that no one wants to buy (except, of course, your freeholder who will be happy to buy it for a knockdown price!).
I recently calculated what effect this would have on a flat with a 999-year lease in Islington. The ground rent was £250 a year doubling every 25 years.
I have calculated that for the last 25 years of the lease, the ground rent would be £165,000,000,000 per year!
It is not just the future implications of the ground rent that you need to look out for if you are considering accepting an informal offer – although that should be enough!
Let’s look at the other areas you need to be aware of.
The terms of your lease
If you extend your lease using your statutory legal right, you are protected by law and your freeholder cannot alter the existing terms of your lease.
If you take up your freeholder’s offer of an informal lease extension, you are not protected and your freeholder can make any changes they wish.
“Wait!”, I hear you cry! “In the offer letter from the freeholder they state that they will not alter any terms of my lease – they will just modernise them!”
In reality, what does the word ‘modernise’ mean?
I can tell you, categorically, that the word ‘modernise’ means whatever terms can be changed to benefit your freeholder.
It is worth pointing out here that the saving your freeholder is offering you with this informal deal comes from the fact that you will have no legal representation through this process.
They are telling you not to have a lawyer to protect your interest throughout this process, but are presenting this fact to you as if they are saving you money! Genius isn’t it?
The truth is, though, that there is no point in having a solicitor represent you in an informal deal as you do not have a legal right to it. It is a ‘take it or leave it’ offer so, even if you found something you were unhappy about, there is no legal mechanism for you to remove it.
So, which terms of the lease is the freeholder keen to change?
Put simply, anything that makes them more money and protects their position as your freeholder.
Licences
The freeholder can insert additional licences to your lease that mean you have to pay them to alter your flat, sell it, rent it out, renew the rental contract each year with your tenant, get satellite TV, turn over to your left side in bed at night, etc.
Two years ago, I spoke to a group of flat owners close to West Ham.
One chap in the audience thought I was exaggerating the issue of informal lease extension, and he went directly to the freeholder of a flat he rented out.
He ‘phoned me a few months later to say that his freeholder had added a clause in his lease, stating that he would have to pay the freeholder 10% of the rental income he receives each month, forever more. The chap wanted to know what he could do about this clause as he had signed the lease a couple of months before and the freeholder was now chasing him for the money!
Changes to some of the clauses of the lease could also have serious implications for the security of your flat, and increase the likelihood of the freeholder trying to obtain forfeiture of your flat (which they love).
They may insert a clause in your lease, which states that if you ever take them to court, for whatever reason (even if your freeholder was caught committing service charge fraud…), that the freeholder’s full legal fees can be reclaimed from you by way of the service charge.
If you sign a new lease with these terms it is now your reality and you can’t alter it.
Be very, very careful regarding the terms of a lease and remember that even if you find bad ones your freeholder has tried to insert, there is absolutely nothing you can do to remove them.
Timescales
The other area to keep an eye on is timescales. I repeat, you do not have a legal right to an informal lease extension and your freeholder can withdraw this offer whenever they want, with no legal recourse at all. Why would they do this?
There are many reasons a freeholder would withdraw an offer, but it’s always so they get more money from you.
For example, you are selling your flat and have a buyer lined up. It may all rest on this informal lease extension, but your freeholder may withdraw their offer claiming there was a mistake on the valuation and they now want £1,800 more.
Chances are you will just pay it!
Freeholders often withdraw an offer when your flat lease length is about to go below the pivotal 80-year mark. The freeholder presents what appears to be good informal offers.
Negotiations are dragged out until there is not enough time to extend your lease through the legal process. The offer is then withdrawn.
The lease has now gone below 80 years and your freeholder’s investment has risen by thousands of pounds and there is nothing you can do about it!
I have lost count of the amount of times I have heard freeholders’ solicitors bragging about doing this to flat owners. If, however, you extend your lease using your statutory rights there are strict timescales by which your freeholder must abide.
Caveat emptor … but solicitors aren’t on your side either
I am shocked by how many professionals recommend that their clients accept informal lease extension without pointing out any of the above.
The big excuse used by all those who recommend that their clients accept informal offers is, “Why are you worried about the details? Let the person who buys your flat worry! You save £1,800 that all you should care about. Caveat emptor!”
If a solicitor or valuer presents a quotation to extend your lease, they have a year-long battle with a knowing freeholder before they get their money. Obviously, if an informal lease extension offer is accepted, they get their money very quickly with little effort on their part.
This is why few professionals point out all the problems I have outlined here.
Five years ago, the argument of ‘let someone else worry about the details’ may have been true, but it’s not a fair argument today.
More and more flat owners and solicitors are looking at the details of informal lease extensions and the onerous terms inserted in the lease.
I now see so many flat sales fall through because someone has not understood the implications of the informal lease extension offered.
Banks and building societies are also beginning to understand the implications of onerous informal deals and the effect these have on the value of flats.
In the big mortgage shake up of April 2014, the Council of Mortgage Lenders brought in more stringent tests for people wishing to get mortgages and these have included looking at the details of a flat sale.
In fact, Halifax has already stated it will take a very dim view on granting a mortgage on any flat where the ground rent doubles every ten years.
What about future legislation changes, which could further highlight these informal deals and thus raise greater awareness of it?
Maybe the people buying your flat won’t understand the future implications of what you have signed up to in your informal deal with the freeholder, but is it really worth taking the chance to save a few hundred pounds in the short term?
How would it affect your future plans if you were stuck with a flat that you couldn’t sell?
Conclusion
Why shouldn’t you accept an informal lease extension from your freeholder?
• It will commit the flat to an additional and needless £100,000 spend over the next couple of decades;
• It is likely that you might have to spend a disproportionate amount to extend the lease in the future;
• It might also cost you a fortune to take part in any future freehold acquisition;
• You risk signing up your flat to lots of unsavoury new lease terms;
• You could massively damage the future resale value of your flat;
• You could end up with a flat no one will buy!
The Trojan horse offer of an informal lease extension really does contain lots of nasty details. These can have very long term repercussions for whoever is unfortunate enough to own the flat.
Most freeholders are professional freeholders and, by and large, they are not your friend.
They own the freehold of your flat for one reason and one reason only and that it to make as much money as they possibly can.
You have no reason ever to trust them, and I implore you never to do so either.