Ground rents sold by auction have moved from being listed at the back of the catalogue and being sold on a multiples of income – perhaps just three or four times income 30 years ago – to now being prized investments, often listed towards the front of the book, writes Guy Charrison.
Data from Essential Information Group shows just how keenly they are fought over by investors: over the past three years, ground rents have sold at an average of 50% above the quoted guide price.
This compares to 4% above guide for AST lots and 6% above guide for vacant residential lots. The exact figures for ground rents have been: 53.5% above guide in 2015; 59.7% above guide in 2016; and 34.3% above guide in 2017.
At Network Auctions we have noticed that where lessees do reserve their rights under section 5b Notices, some investors are put off from bidding because the lessees can effectively take over the purchase at the price the lot is sold for at the auction.
But generally we find that we are at or very close to achieving 100% of the enfranchisement value for GR investments, a big change over the years.
How should you approach ground rents at auction?
Different buyers may consider differing angles: the current and future ground rent income is just one factor; the opportunity to earn fees from the block management would appeal to those who would consider managing the property themselves but less to more armchair investors.
The potential for lease extensions should be considered: any lease length of 90 years or less potentially has value for lease extensions.
Other “angles” could include the potential for further development to the property or site. One of my clients told me he purchased a block where there was a vacant former caretaker’s flat. The selling agent and vendor didn’t realise – or had forgotten – so my client found himself with a “free” flat.
Take into account what potential you think the building has and how much you would want to pay for “hope value”.
What makes a good ground rent investment?
If you are focussing solely on GR investment, then GR income and potential lease extensions are likely to be your main concern.
Others are looking at future development: one block I sold recently had some development hope value and sold at a higher price than I or the seller expected. After the sale completed I asked the buyer how he came to his conclusion on price.
His answer: “Well, I have either paid too much or if I get planning permission to create another floor I have purchased it very well.”
The seller later told me he had tried to develop the property himself over the years without success. He also said he had done very well with his GR investments over the past 50 years, having purchased many of them years ago at just three times the GR income.
A good investment to some would be a clean well-managed block. Others prefer “active” management where they can make fees as the managing agent and if they also own flats in the block they can improve the capital value of their owned flats and thus the flats generally, which will improve the lease extension premiums in the future.
How can you manage your ground rent investments to enhance income and value?
■ Appoint a good managing agent which can provide a good service to both landlord and tenants; that can be much better than lessees taking their rights to self-manage.
■ Make sure lessees are communicated with, especially when works are needed or proposed. Better to have had clear proposals than surprised and unhappy lessees receiving unexpected demands.
■ Appoint a surveyor with enfranchisement experience for lease extensions. Many landlords prefer their surveyors to negotiate terms outside the 1993 Act: offering a lesser term than the additional 90 years being added to the current term and to have a reasonable ground rent rather than peppercorn. Have a good lawyer for lease extension work too – one with knowledge of enfranchisement.
■ If you are selling, consider selling to the lessees first, you can always approach them informally, I have done this successfully for clients and obtained a stronger price than I think we would have by a more formal method of sale and valuation. Sometimes asking them to meet with you works well.
■ Consider the demise of the lessees’ interest: perhaps they don’t own the loft and may wish to consider a loft extension or have even completed the work without the landlord’s consent. Sometimes a drive by look can be fruitful. I am dealing with a GR investment at the moment where the lessee has erected a sizeable lean-to extension. We noted this following a casual inspection. The lessee has approached us to carry out a lease extension and we now feel we can ask if they wish to take the lean-to down or formalise it under the terms of the lease subject to a premium being paid. They may still need planning consent.
■ Also consider if it is possible to build garaging or create parking spaces that can be rented. Again the demise of the area to be developed would need to be considered. You can also negotiate with lessees: Tony Haines of Highpoint Investments, for example, successfully offered lease extensions to lessees in exchange for the right to build an additional floor of flats where the lessees demise was over the roof.
It pays to think in the long term
Chris Leete of Leete Estate Management in Windsor, says that some landlords prefer more active management and opportunities for enforcements.
He says landlords should consider their long-term investment with a view to maximising the opportunity to encourage enfranchisement or applications for lease extensions. This can be achieved by: appointing good managing agents; carrying out regular inspections; and budgeting for long-term maintenance programmes and reserve forecasts.
Well-maintained buildings will be more desirable, leading to a higher standard of both tenants and owners and an increase in values and rental income. Leete says he has seen a substantial increase in the number of freehold enfranchisement notices in the past few years.
Applications for lease extensions also increase on well-managed blocks with high standards of grounds maintenance, decoration and renewal of fixtures and fittings. His advice is to think long term and not just about the annual ground rents.
Steven Hall, senior partner at Pearce & Co Managing Agents in Chertsey, says he would advise clients to think about when they would like their lease extension premiums to come in. You might be buying to fund retirement or your children’s education so ideally they would have fallen below 80 years at that point.
Consider what return you expect from your investment and take into account the likely cost of collection of the ground rent.
Smaller lots suit smaller pockets, whereas institutional investors generally focus on modern, substantial portfolios with increasing ground rents linked to RPI or capital value. Private investors should bear in mind that inflation erodes the value of money, so increases are preferable to fixed income levels which may ultimately become worthless.
Also check the location: a shabby property may indicate limited means and a lot of management time needed to collect rents.
Selling the freehold
If a freeholder wishes to sell by private treaty they must serve a Section 5a Notice on all the flat owners giving them the right of first refusal.
■ If at least 50% of the flat owners wish to accept the landlord’s offer the landlord must sell the freehold to them at the price that he has offered.
■ If all of the lessees do not wish to take up the opportunity the 50% or more that do can still proceed but will need to pay proportionately more. They could profit later when lessees who didn’t take up the opportunity wish to extend their leases.
■ If the freeholder decides to sell at auction, they will need to issue a Section 5b Notice. This gives notice of the sale of the asset by public auction and gives the lessees a right to effectively takeover the purchase – if they have reserved their rights – at the price the lot is sold for at the auction.
Enfranchisement
The 1993 Leasehold Reform, Housing and Urban Development Act gives qualifying tenants the right to act together to purchase the freehold of their building.
Lessees often wish to do so to control the management of the building, especially when they feel this has been done poorly, as well as where the terms of the lease or certain covenants and/or ground rents are onerous.
The building must contain at least two flats held by ‘qualifying tenants’ with not more than 25% of the internal floor area being non-residential. At least 50% of flat owners need to take part. Tenants must own no more than three flats in the building to qualify.
The freehold purchase is normally instigated by the lessees deciding to collectively enfranchise; this can be done informally by direct negotiations with the freeholder either by the lessees or by them appointing a surveyor.
If the freeholder does not wish to enter informal negotiations, the lessees can force the sale of the freehold and ultimately the price will be determined by the Leasehold Valuation Tribunal if a price cannot be agreed. The LVT will take into account one half of the marriage value, which is the value attributed to the freehold as a result of the participating tenants being able to grant themselves extended leases at nil premiums and peppercorn rents and will only apply to flats with leases of less than 80 years to run. The date the initial notice is served will be considered as the valuation date.
It is often very difficult to get a collective enfranchisement especially for larger blocks when different lessees have very different opinions and financial positions.
Many lessees are happy to extend the lease on their own flat and qualifying tenants have the rights to extend their leases by an additional 90 years to the existing term and with the ground rent going to peppercorn.
This makes the asset more saleable and retains the asset value and gives the ability for a buyer to obtain a mortgage. Many lenders require a term of at least 70 years at the start of a new mortgage.
Guy Charrison is a past president of the National Association of Valuers and Auctioneers and principle auctioneer and director of Network Auctions
