Business focus: Cracks show for developers as ground rent proposals send tremors through industry

Legislation looming: McCarthy & Stone homes in Sutton, south London

27 June 2018

The boss of McCarthy & Stone, a UK property giant that specialises in building retirement homes, is the sort of man who would vehemently disagree with Ernest Hemingway’s assertion that “retirement is the ugliest word in the language”.

So it is with painful irony that Clive Fenton has just found himself “retiring” from the board at just 60 years old.

The chief executive last week announced his departure alongside a shocking warning that full-year profits at the FTSE 250 company will be lower than the City expected.

He pointed to economic uncertainty and a slower housing market. But it was the “additional challenges” he referred to that sent fresh tremors across parts of the property industry: a potentially game-changing ban on ground rents.

The Government’s proposal to set ground rents on new long leases to zero could see the likes of property tycoon Vincent Tchenguiz, who has around 250,000 residential freeholds worth £4 billion, scale back acquisitions of new-build apartments. That would leave developers with less money to construct desperately needed homes — but more on that later.

Tchenguiz is among investors, funds and developers on tenterhooks awaiting the next government update on leasehold practices. As Fenton bluntly puts it: “Until we have clarity we are unable to compete effectively in the land market.”

So what is ground rent? Its origins trace back to the Norman conquest but at its simplest, it involves a leasehold owner of a property paying an annual fee to a freeholder, which owns the land on which the property stands. It is meant to ensure the freeholder maintains a long-term interest in the asset.

Levels of ground rent vary, but residents at a McCarthy & Stone flat, for example, might pay around £500 a year in ground rent. This cost is fixed for 15 years from purchase and increases in line with inflation every 15 years.

The company relies on ground rent income to help pay for the construction of expensive communal areas it provides for residents, such as lounges, hair salons and dining rooms. It can sell on the freehold at any time, often to pension funds, which leaves McCarthy & Stone as the landlord and only point of contact for residents.

The ground-rent deal remains the same as originally signed for by the leasehold buyer. A similar model applies to other blocks of flats and, in some cases, housing estates.

But some people claim ground rents can make their homes almost unsellable as lenders will often not offer mortgages against them. Sebastian O’Kelly, who runs charity Leasehold Knowledge Partnership, believes they are “for no defined service whatsoever”.

Housing London’s ageing population

If builders are deterred from investing in flats for pensioners, the already squeezed £29 billion UK retirement housing market will come under serious strain.

Although the capital is known for its younger demographic, there are still more than one million people aged 65 and over in London.

However, there are just 63,000 dedicated retirement apartments that they could live in, according to Tom Scaife, a partner at estate agent Knight Frank.

He adds: “With the draft London Plan indicating that around 4000 retirement units a year will be delivered across London boroughs up to 2029, it is evident from the increasing growth of the over-65 age cohort that, even with the additional properties, there will still be a considerable undersupply issue in the capital.”

The system has come under the spotlight in recent years because of higher and rising rents. That is in response to land becoming more expensive, and larger, more complex developments.

In one high-profile case, housebuilder Taylor Wimpey had clauses in some contracts that doubled the ground rent every decade, meaning those who bought a lease in 2007 with a £250-a-year charge, would pay £500 annually from 2017, rising to £8000 in 40 years’ time. It last year said it would pay out £130 million to help customers caught up in the scandal.

Concerns prompted the Government to launch a consultation, and in December it shocked the industry by saying it would look to ensure ground rents on new long leases in England are set to zero, for both houses and flats. McCarthy & Stone shares dropped 9.5%.

A spokesman for the Ministry of Housing, Communities and Local Government says: “It’s unacceptable for homebuyers to be exploited through unnecessary leaseholds, unjustifiable charges and onerous ground rent terms.” It plans to bring in new legislation as soon as parliamentary time allows. The industry expects more detail or consultation shortly.

While future homebuyers may be celebrating, the mood in boardrooms couldn’t be more different. It comes at a time of cooling markets which is causing its mortgage-free cash buyers to sit on their hands. Spencer McCarthy, who runs Churchill Retirement Living, thinks a “reasonable ground rent on fair terms” is vital for funding communal areas. He warns: “Without it we won’t be able to deliver the volume of new homes that are needed to meet the demands of our ageing population.

McCarthy’s Fenton says he supports government efforts to “eliminate bad practices”. He’d be happy to offer residents the choice of paying more upfront instead of ground rents annually, but this would mean adding as much as £20,000 to price tags.

It’s not just those building for OAPs who are worried. Experts think if conventional housebuilders can’t sell ground rent portfolios, it will be harder to market the freeholds, leaving them with less capital to invest in landbanks. Simon Allison, property barrister at Hardwicke chambers, says freehold interests could become “commercially worthless”.

Richard Silva is a principal at fund management company Long Harbour, which manages numerous freeholds on behalf of UK pension funds.

He supports the drive for greater regulation of the industry but thinks a ground rent ban “will reduce significant investment into the residential sector, and remove a much needed safety net provided by professional freeholders to homeowners”.

Companies that could see projects be less financially viable include London-based Hadley Property Group, which says it hadn’t factored the proposals into the costs of planned new works. Donagh O’Sullivan, chief executive of Galliard Homes, thinks a zero rate would deter him and rivals from committing to certain developments. “It would be a daft move,” he says bluntly.

The Home Builders Federation wants to ensure leasehold terms are fair and transparent. However, a spokesman adds: “Ultimately someone has to have responsibility for the building to ensure its sustainability — and responsibility comes at a price.”

If the Government goes ahead with the zero plan, it will cost parts of the UK residential market hugely. That might mean Britain’s housing shortage gets even uglier.

Money worries

In 2008, Rosemary Marshal, then recently widowed, bought the lease for, and moved into, a one-bedroom flat developed by Churchill Retirement Living in Chichester.

The freehold has since been sold by Churchill. The starting ground rent was £550 per year; today it is £655.86.

Says 76-year-old Marshall: “It is not easy for me to pay the ground rent, but the most important thing is the worry about the future as my small pot of money dwindles.

“There are big advantages of living here, not least a happy community, but the ground rent is always at the back of my mind.”

Business focus: Cracks show for developers as ground rent proposals send tremors through industry

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