Tackling unfair practices in the leasehold market

Tackling unfair practices in the leasehold market UK Finance response to the DCLG consultation September 2017 Introduction UK Finance is a trade association formed in July 2017 to represent the finance and banking industry operating in the UK. It represents around 250 firms in the UK providing credit, banking, markets and payment-related services. The new organisation brings together most of the activities previously carried out by the Asset Based Finance Association, the British Bankers Association, the Council of Mortgage Lenders, Financial Fraud Action UK, Payments UK and the UK Cards Association. For any queries in relation to this response, please contact jennifer.bourne@ukfinance.org.uk. Scope of response and background UK Finance represents residential mortgage lenders who regularly lend to those wishing to purchase leasehold properties in England. Lending on leasehold does present additional risks when compared to lending on freehold. These can be broadly categorised as: Risks around the property s marketability, saleability and value, depending on the lease term left and the terms of the lease. Risks for the lender s interest in the property, in the event that the borrower tenant breaches the lease in some way, triggering the landlord s rights of forfeiture. Challenges in assessing the borrower s future ability to afford the mortgage payments, given future known and unknown financial obligations under the lease. Recent concerning practices within the leasehold sector have heightened some of these risks and challenges, and the mortgage lending industry therefore welcomes the opportunity to respond to this consultation. Lenders share the government s concerns about inappropriate use of leasehold and escalating ground rents, but recognise that leasehold is an appropriate tenure in the right circumstances, for example where properties have shared services or are built on land with specific restrictions, or where it is appropriate for certain housing tenures such as shared ownership. Executive summary We make the following proposals and calls to action: Limit the sale of leasehold houses, to specified exceptions and those exceptions must include safeguards against onerous lease terms. Steps should be taken, in parallel, to mitigate the impact on existing leasehold houses. Providing key leasehold information about the length of the lease, the ground rent level and review methodology, and other charges, to be provided to prospective buyers, up front and in simple terms; alongside measures to ensure that new residential leases have standard, simple and fair terms. That action is taken to address onerous leasehold terms in existing leasehold properties (whether houses or other property types). UK Finance is the trading name of NewTA Limited. Company number: 10250295. Registered address: Pinners Hall, 105-108 Old Broad Street, London, EC2N 1EX

Reform the suite of leasehold legislation, ensuring more consistency of leaseholder rights, providing safeguards against excessive ground rents and other charges; and more balanced legislative rights and remedies. That Ground 8 of the Housing Act 1988 is amended so long leases over 21 years with an annual ground rent over 1,000 in London and 250 outside of London cannot be an Assured Tenancy. We support a review of the commonhold tenure. New build leasehold houses We agree that there should be a restriction on the ability of developers to sell new build leasehold houses, where there does not appear to be a justification for use of the leasehold tenure, to prevent use of the tenure as an income stream. We note that DCLG estimate that new build leasehold house sales are up from 7% of leasehold transactions in 1995 to 15% in 2016. As the consultation notes, the increase in sales of new build leasehold houses, particularly where there is no established practice or reason for them, may be linked to the ability to create a revenue stream. Some of our members have expressed concern over the practice of some developers to sell identical houses in the same development either on a leasehold or freehold basis, with a small price differential. This suggests there may be deliberate commercial strategies around selection of the tenure of new build properties. For lenders and their valuers, it can also add to the difficulty in valuing new build properties, where there is so-called two-tier pricing on sites. Where there is difficulty in assessing the value, lenders may react by adjust their loan to value thresholds, to ensure that they are not overly-exposed should the property values drop. Some lenders may also limit their exposure on new build sites. Potential reforms Legislative reform could introduce restrictions to the sale of leasehold houses. We agree with the exceptions listed in the consultation document and that this should include affordable housing tenures such as shared ownership, which typically use a leasehold structure. We believe that any government policy around limiting the sale of leasehold houses going forward, should also require that where the sale of a leasehold house is permitted, the level of ground rents chargeable and any other linked charges (e.g., where fees are charged for permission to alter the structure of the property are linked to the ground rent calculation) are also restricted to ensure that the rents charged are not onerous. Outside of legislative change, government could introduce restrictions on leasehold houses via schemes such as the Help to Buy Equity Loan scheme, which we discuss further below. Reform led by the house-building sector would be welcomed. Clearly this is more easily achieved on brand new housing developments before any sales are completed but we understand some residential developers are reviewing how they might switch on existing sites from selling houses with leases to selling freeholds (where the developer itself owns the freehold title). We support industry wide work on this. However, this does create issues around reconciling previous sales of leasehold houses on sites and ensuring that those who have bought prior to any action taken to switch tenure are not disadvantaged. It will also create a challenge for valuing such sites, where comparable properties may have been sold on a variety of tenures. It is also vital that prospective purchasers of leasehold properties, whether they be houses or other types of property, are properly advised about what leasehold means, and what financial obligations they have as a result, both at point of purchase and in the future. It should be mandatory to provide key leasehold information about the length of the lease, the ground rent level and review methodology, and other charges and their review methodology, to the buyer, within the particulars for the property, whether it be newly built or an existing leasehold. Help to Buy Equity Loan We agree that that sale of leasehold houses under the Help to Buy Equity Loan scheme (HTBEL) should be limited, as part of a general policy approach to limit the sale of leasehold houses other than by exception. We note that this could be implemented by a change to the scheme s rules and eligibility, and could therefore be implemented relatively swiftly. The HTBEL scheme forms a large proportion of many developers sales and therefore should have an immediate impact on reducing the numbers of leasehold houses for sale. However, because the scheme forms a major contribution to many developers sales, there is a need to consider how any changes to the scheme will impact on existing sites. There will be a need to mitigate the risk of blight for

existing leasehold houses sold under the scheme and on earlier phases of a current development, if the developer plans to convert or cease selling houses as leasehold, as we note above. In terms of how to enforce such a requirement, as the consultation notes, this could be done without the need for legislative reform, simply by amending the scheme to prevent the sale of leasehold homes except for specified exceptions. We consider that this could be achieved by there being a burden of proof on the developer, to provide evidence to the Help to Buy Agent, prior to the issuing of an authority to proceed, if they believe there is a valid reason for selling as leasehold; and alongside that, details of ground rents and other charges so that they can be assessed for reasonableness. Impact on existing leasehold stock Any policy to limit the sale of leasehold houses going forward, must recognise and mitigate the impact on existing stock of leasehold houses which fall outside of any specified exceptions. An obvious potential issue will be blight on the value of existing properties, which could impact on both owners and their mortgage lenders. It will be important to mitigate this risk of blight. One way this could be mitigated is by simplifying the enfranchisement process for existing leasehold properties to move to a freehold tenure, enabling more to benefit from having the freehold of their home. We are aware that the current enfranchisement process is seen as complex and expensive, and the assessment of the cost of enfranchisement is not straightforward from a valuation perspective, as the cost must reflect the precise terms of the lease, so these issues will need to be addressed. Leasehold terms Our members have cited concerns over onerous and complex leasehold terms. We asked members to provide examples of lease terms in relation to ground rents which they considered were onerous. We received just over 20 examples from across the membership, and the leases ranged in age some were examples from the secondhand market, others were leases for newly-built homes. Key themes emerging from the examples provided were frequent review periods (ranges provided were between 10-25 years), with relatively high starting ground rents. Some ground rent calculations were also complex in nature, which, in turn, may have made it more difficult for the purchaser to fully understand the implications of the ground rent liability over time. While some examples were given that were linked to RPI, the high frequency of review was a cause for concern. It is difficult, however, to provide absolutes around what is reasonable, as it will depend on the interaction between a range of terms within the lease. Aside from ground rents, the levels of estate and service charges, and fees for certain events or consent are also of concern to our members, who have reported seeing examples of unreasonably high costs. We would support proposals which ensure that such charges and fees are reasonable. A scale of fees could be developed, for quantifiable administrative activities in connection with the sale, ongoing ownership and purchase of a leasehold property, which includes any exit or transfer fees payable. There are inconsistencies in protections available to leaseholders, or those with leasehold-style obligations depending on the type of property they own, which also have impacts for those lending to leaseholders. For example, leaseholders within a local authority property have fewer rights to challenge service charges than leaseholders within the private sector. And, as the consultation notes, those who live on a freehold estate may also be subject to unfair charges. There should be a consistency of protection. We would support a rationalisation of both leasehold and wider land legislation to provide a simpler, fairer legislative framework. Potential reform To help reduce the risk of unfair and unnecessarily complex lease terms going forward, government should engage with the legal sector and other stakeholders on whether model residential lease clauses could be developed. As discussed above, having key leasehold information at the point of enquiry, such as the way in which ground rents increase over time, would be a significant step towards ensuring the prospective purchaser can make an informed decision. The Key Facts Illustration, a regulatory requirement for many financial services products, is an example of mandated information, set out for the consumer to easily understand, in a prescribed format. This could be used as a model for improving leasehold information, or indeed all key property particulars available at point of enquiry. Impact on existing leasehold stock Model residential lease clauses will not address the issue of existing lease terms which may be onerous. The government should consider targeted legislative reform aimed at supporting existing leaseholders, and encourage initiatives aimed at supporting existing leaseholders such as variation of onerous terms by freeholders. However, to avoid lengthy legal challenges, we believe the government will need to define exactly what is considered onerous.

The government will also need to consider developing a dispute resolution process which is inexpensive for consumers to access and avoids the need to incur high levels of cost, for example an ombudsman, as an alternative to the First-Tier Tribunal. We have set out some considerations that lenders have in relation to determining whether a ground rent is onerous in our response to Question 14. Other reform The law of forfeiture Members regularly end up paying demands for service charges and ground rents in cases where the borrower is in arrears and the landlord is preparing to take action for forfeiture of the lease. Lenders often are forced to act, after being advised at a late stage of the issue, to prevent the lease security being forfeited. Very frequently there is only a short amount of time given to respond to these requests. This is most frequently anywhere between 7 and 14 days. In this time, the lender must contact the borrower and determine whether it is appropriate to pay the amount requested. Lenders report that is not uncommon for the firms requesting payment to begin chasing for it well before the deadline expires. This puts additional pressure on the lender to make these payments on behalf of the borrower, without first having had opportunity to discuss the situation with the borrower. There can also be confusion around these requests due to the way they are presented. This makes it difficult to determine whether it is appropriate to make the payment. It can be unclear what the request relates to (e.g. service charge, ground rent, or freehold rentcharge); whether the lender s security is at risk; and how much of the amount requested must be paid to avoid forfeiture. In such cases, the lender s only option is to add the payments to the overall debt that the borrower must pay. In many of these cases, the borrower is already in financial difficulty and may also be in arrears with their mortgage. Under current law, there is no obligation on the landlord to give notice to the lender of the termination proceedings. Some of our members have reported that some landlords or their agents are issuing proceedings without any contact with the lender but then serving the proceedings on them along with a Part 36 Offer to Settle, which carries a cost risk. This behaviour puts pressure on all concerned. We have previously made submissions in support of the Law Commission s proposals around the law on termination of tenancies for tenant default, which suggested abolishing the law of forfeiture and replacing it with a simpler and more balanced regime. We would support a reconsideration of these proposals by government as part of the wider reform of the leasehold tenure. We also support a wider review of the patchwork of legislation covering leasehold and other forms of property tenure to ensure that appropriate protections are in place for all parties, and that the legislation rebalances the rights and obligations of the parties more fairly. We have also discussed with members, the development of a draft pre-action protocol for proceedings in relation to termination of tenancy. The protocol could cover matters such as the precise nature of the charges claimed for, the basis for claim, and the exact amount claimed, together with reasonable timeframes for response from relevant parties. Such a pre-action protocol could drive better outcomes by encouraging clarity around the basis for the claim, early engagement with all affected parties, and sensible timelines for all parties to work toward in resolving complaints. This could be put in place earlier than legislative change. The Housing Act 1988 The provisions of the Housing Act 1988 in respect of the creation of an Assured Tenancy under Ground 8 of Schedule 2 where ground rents exceed 1000 per year in Greater London or 250 elsewhere, create a disproportionately harsh outcome for leaseholders, and lead to issues as described above in relation to the law of forfeiture. The Act should be amended to address this unintended and unfair consequence of the Act. Other fees and charges under leasehold As noted earlier in this response, members have provided anecdotal evidence of high levels of other charges and fees contained in lease terms, or charges levied against freehold owners within an estate. We would support development of a scale of fees for quantifiable administrative activities in connection with the sale, ongoing ownership and purchase of a leasehold property, including any exit or transfer fees payable.

Service/estate charges and freeholders The consultation highlights the rights of freeholders in respect of their ability to challenge service charges for the maintenance of common areas of estates. We support greater rights of challenge, as our members have reported seeing unreasonable charges in this context. Rentcharges Many of the issues which arise in relation to resolving disputes over ground rents and service charges also arise in the context of rentcharges. Therefore, we would urge that any reform made to address unfair practice in the leasehold sector, is also extended to not just freeholders who may be subject to similar issues as leaseholders, but also those who may have a property subject to a rentcharge. Another area of potential concern is the increasing practice of creating covenants on freehold. As a general point, care must be taken to ensure that a thorough review of relevant legislation is undertaken to ensure that where avenues of potential exploitation are closed off in relation to leasehold, other areas for exploitation, such as freehold rentcharges and estate charges, have similar protections built in. Commonhold Prior to the Leasehold and Commonhold Reform Act, lenders were supportive of the introduction of commonhold. Since its introduction however, the tenure has had extremely limited uptake. This has meant that the tenure remains untested in relation to some of the concerns which were raised by lenders at the outset and subsequently, namely: The extent to which the winding-up / termination provisions within the 2002 Act sufficiently protect the lenders security interest. Reconciling shared ownership, an important affordable housing tenure, which relies on a leasehold relationship between social landlord and tenant, with use of commonhold which does not permit leases over seven years. Similarly, how commonhold might be reconciled with Islamic financing constructs, which can involve leases. How well commonhold management companies would, in practice, maintain the shared amenities, given the potential for inexperience and disputes to create risks around the shared maintenance of properties. We support a review of the existing commonhold legislation, and stand ready to engage as required with government and others. Response to consultation questions Q5: What steps should the Government take to limit the sale of new build leasehold houses? We agree that there should be a restriction on the ability of developers to sell new build leasehold houses, where there does not appear to be a justification for use of the leasehold tenure, to prevent use of the tenure as an income stream. However, any steps to limit the sale of leasehold houses going forward, will also need to mitigate blighting the value of the existing stock of leasehold houses which fall outside of any specified exceptions. Q6: What reasons are there that houses should be sold as leasehold other than under the exceptions set out in paragraph: within a cathedral precinct; on National Trust or Crown land; on land owned by local authorities and university bodies with the right for future development; in shared ownership with a restricted staircasing lease; and of special architectural or historic interest or adjoining properties where it is important in safeguarding them and their surroundings. We agree with the list of exceptions. We also suggest that Community Land Trusts are considered for inclusion within a list of exceptions, as we understand they use a leasehold structure to ensure that properties remain affordable for the long term.

Q7: Are any of the exceptions listed in 3.2 not justified? Please explain We believe there are justifications, but there does need to be appropriate parameters to ensure that the lease terms are not onerous for example, shared ownership lease terms and modern ground rent chargeable under a national trust lease must also be required to be reasonable. Q8: Would limiting the sale of new build leasehold houses affect the supply of new build homes? Please explain. We feel that others will be better placed to comment on whether it would affect the supply of new build homes. Q9: Should the Government move towards removing support for the sale of new build leasehold houses through Help to Buy Equity Loan, unless leasehold can be justified and where ground rents are reasonable (which could be a nominal or peppercorn ground rent), and if not, why not? Yes, as part of a general move toward the use of leasehold houses only when there is a justifiable exception. As above, there will be a need to mitigate risk of blight for existing leasehold houses, and consider whether it is practicable for sites currently under development to transition any leasehold houses to a freehold tenure. The position of those who have already bought a leasehold house on the site will also need consideration. Q10: In what circumstances do you consider that leasehold houses supported by Help to Buy Equity Loan could be justified? Only where the house falls within an approved exception. Q11: Is there anything further the Government could do through Help to Buy Equity Loan to discourage the sale of leasehold houses? Please explain. If proposals to limit the sale of leasehold houses, linked with controls around ground rents for those houses that need to be sold on a leasehold basis, are put in place under the scheme, we expect this will cover a significant proportion of leasehold house sales, given the popularity of the scheme with developers and buyers. Q12: What measures, if any, should be considered to minimise the impact on the pipeline of existing developments? We feel others will be better placed to comment on how best to minimise the impact on pipeline. Q13: What information can you provide on the prevalence of onerous ground rents? We are keen to receive information on the number and type of onerous ground rents (i.e. doubling, or other methods) and whether new leases are still being sold with such terms. We asked members to provide examples of lease terms in relation to ground rents which they considered were onerous. We received around 20 examples from across the membership, and the leases ranged in age some were examples from the second-hand market, others were new leases. Key themes emerging from the examples provided were frequent review periods (c10-25 years), with relatively high starting ground rents, and no caps. Some ground rent calculations were also complex in nature, which, in turn, may have made it more difficult for the purchaser to fully understand the implications of the ground rent liability over time. While some examples were given that were linked to RPI, the high frequency of review was a cause for concern. Q14: What would a reasonable ground rent look like, in terms of i) the initial annual ground rent, ii) the maximum rate of increase in annual ground rent, and iii) how often the rate of increase could be applied to an annual ground rent? Please explain your reasons. i) initial annual ground rent ii) maximum rate of increase in annual ground rent iii) how often the rate of increase could be applied to an annual ground rent It is difficult to be prescriptive as to what is reasonable, as there will always be grey areas, especially as the ground rent provisions may need to be considered within the context of the lease as a whole. In prescribing what is reasonable, we note that any leasehold property outside those parameters will be immediately impacted.

Initial annual ground rent The key considerations of lenders will be around: The level of the ground rent in relation to the property s market value. The type of property (e.g. a flat or a house). Whether the ground rent is fixed or rises periodically. If the ground rent does rise periodically, the formula by which it rises. Where the property value is below a certain threshold, some lenders may wish to see a de minimis maximum initial ground rent figure applied. Whether the ground rent figure is at a level which triggers legislative provisions (such as Schedule 8 of the Housing Act 1988), as this potentially creates a risk for the lender s security. A maximum rate of increase of ground rent The UK Finance Lenders Handbook, which is a set of standard instructions from lenders to conveyancers acting in a residential house purchase transaction involving mortgage finance, provides generally that lenders may be prepared to lend where there is increasing ground rent, providing the amount of the increased ground rent is fixed or can be readily established and is reasonable. While it is difficult to provide prescriptive parameters around the maximum rate of increase, from a lending perspective the primary concern will be to ensure that the increase in ground rent does not create either affordability issues or impact on the value of the property. Where the formula is one which uses increases in line with an index, lenders will look at whether the index is a recognised UK index and is appropriate and/or acceptable to them. Some lenders may be concerned to see the use of compounding formulas, or the use of minimum increases, in conjunction with an index-linked formula. Where the formula does not link with a recognised index, and instead uses a multiplier (e.g. doubles) at set intervals, the frequency of the rent review intervals will be very relevant. Some lenders may also expect a cap on the maximum ground rent amount. How often the rate of increase could be applied to an annual ground rent There is no single industry view on a minimum acceptable frequency of increase, as it may depend on other factors such as the initial amount of the ground rent, and whether there is a cap on the number of times the rent is reviewed. Q15: Should exemptions apply to Right to Buy, shared ownership or other leases? If so, please explain. We believe that all leases should have reasonable ground rents, regardless of type. Q16: Would restrictions on ground rent levels affect the supply of new build homes? Please explain We feel others are better placed to comment on this. Q17: How could the Government support existing leaseholders with onerous ground rents? The government should consider targeted legislative reform aimed at supporting existing leaseholders, and encourage initiatives aimed at supporting existing leaseholders such as variation of onerous terms by freeholders, and facilitation of the enfranchisement process for leaseholders. Q18: In addition to legislation what voluntary routes might exist for tackling ground rents in new leases? We welcome steps being taken by developers to review existing leases and voluntarily take steps to mitigate onerous leases which they have identified; and change their approach to lease terms on properties they are selling going forward, to address concerns over onerous provisions. Some of our members have reviewed their own policies in relation to what they are prepared to lend on in relation to leasehold. We, as an industry, cannot set blanket lending policy. However, UK Finance has produced a document which sets out the range of considerations for lenders and their advisers concerning lease terms for new build leasehold properties in England and Wales.

Q19: Should the Government amend the Housing Act 1988 (as amended by the Housing Act 1996) to ensure a leaseholder paying annual ground rent over 1,000 in London or over 250 in the rest of England is not classed as an assured tenant, and therefore cannot be issued with a Ground 8 mandatory possession order for ground rent arrears? If not, why not? Yes this can create a risk for owners and mortgage lenders as it currently stands. Q20: Should the Government promote solutions to provide freeholders equivalent rights to leaseholders to challenge the reasonableness of service charges for the maintenance of communal areas and facilities on a private estate? If not, what management arrangements on private estates should not apply? We would support additional rights for freeholders in this context. Q21: The Housing White Paper highlights that the Government will consult on a range of measures to tackle abuse of leasehold. What further areas of leasehold reform should be prioritised and why? As detailed in the body of our response, we support a review of the law of forfeiture with a view to implementing the Law commission recommendations of 2006; a simplification of the process to extend the lease and buy the freehold; a scale of fees for administrative activities in relation to leasehold and other charges; mapping across any leasehold reform designed to better balance the rights of parties to other areas such as freehold charges and rentcharges, to prevent exploitation in these areas; and a review of the commonhold tenure.