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Article for Residential Property Investor Magazine by Jeremy Davies of GroundRentsWanted

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Ground Rents are the most widely owned but least understood property type. Originally the result of ground leases from landed estates to speculative builders in the early 1900s, they are now the unifying feature of Victorian house conversions and modernist council estates. Owners range from the house-builders , to trustees of probate estates to highly specialised ground rent investment companies. In this article I will discuss how they are created, emerging government legislation on their management and changing face of ground rent ownership in the UK in light of the credit crunch.

What are ground rents?

A ground rent is created when a residential unit is sold on a long leasehold basis. They are typically on new build schemes of apartments or sub-divisions of period houses. The owner of the freehold is entitled to receive a ‘ground rent’ from the long leaseholder, and may be entitled to recover the cost of insurance and management.¬† The value of the ground rents is typically 1-2% of the Gross Development Value of the apartment scheme. Payment of ground rent is made annually by the lessees to the ground rent owner. Conflicts of interest can arise when the ground rent owner also provides management services to the apartment blocks, which can lead to problems for the original developer, vendors need to be conscious of the importance of protecting their reputation. As such reputable ground rent investment companies normally employ external professional managing agents.

What legislation affects ground rents and their management?

The Rugg Report highlighted the benefits of a compulsory licensing scheme for Managing Agents to drive up standards in the administration of apartment schemes, but stopped short of calling for compulsory registration of all ground rent owners. As a landlord we would support greater oversight for Managing Agents, as currently even membership of industry body ‘The ¬†Association of Residential Managing Agents’ is not compulsory. The image of the ground rent industry is closely correlated to that of managing agents, as they represent the landlord in correspondence with leaseholders and the maintenance of buildings. As such their probity is to the benefit of all parties.

Ground Rent transactions are subject to legislation which gives the long leaseholders the right to match the sale price. These are known as Section V notices, and mean any ground rent sale must be delayed for a two month period while the notice period for the right of first refusal expires. If long leaseholders wish to take up their rights of pre-emption they then have a further two months to nominate a purchasing entity. As an active investor we normally serve the Section V notices free of charge, and record circa 10% of the long leaseholders taking up their right to buy. The long leaseholders require at least 50% participation, so the bigger the scheme the lower the likelihood of take-up.

How has the credit crunch affected the ground rent market?

In some cases a residential developer will have formed a Special Purpose Vehicle to develop an apartment scheme. They are often keen to wind up the companies to reduce accountancy fees in future years and cut down on paperwork. After a successful sale of the apartments ( say in the boom years of 2002-2006) they might have given little thought to selling, or in some cases even collecting, the ground rents. In today’s harsher times however developers are increasingly looking to make strategic land purchases from distressed vendors, and the receipts from ground rent sales provide the means.

Ownership of ground rents benefits from economies of scale. The business consists of collecting small amounts of money from a large variety of people, some of whom may be baffled by the arrival of a ground rent invoice. In addition legislature governing the administration of rental demands for ground rents differs from that of more straightforward residential properties, at GroundRentsWanted our invoices are now accompanied by four A4 sides of statutory paperwork.

The opportunity to deploy the capital better elsewhere, especially in the current economic climate is also high on our counterparties list of priorities. Banks are reluctant to lend on individual ground rents, and so most owners are unable to ‘gear them up’ to maximise the returns. As people seek to reduce the Loan to Value ratio of their residential mortgages they are increasingly looking to sell non-core assets to free up cash.

What are my ground rents worth?

The value of a ground rent is a combination of the passing income and the unexpired term on the lease. The income receivable annually as ground rent is more valuable if it has frequent rent review provisions, or goes up with inflation. The shorter the lease length remaining the higher the value of the ground rent, as the nearer the property is to reversion.