Doubling and RPI ground rent; issues for leaseholders

Ground rent is an annual payment made by a leaseholder (tenant) to the freeholder (landlord). Typically, this payment is a fixed sum that varies from lease to lease. While ground rents are generally modest, issues arise when ground rents are escalating over time, particularly when they exceed certain thresholds or increase too quickly.

Some modern leases have doubling ground rents which can be an issue for a flat purchaser or mortgage company.

Escalating Ground Rent: A Growing Concern for Leaseholders

Escalating ground rent is an increasingly common issue, where the rent increases periodically (usually every five to twenty five years), often tied to an index like the Retail Price Index (RPI). This is despite the RPI being criticised by experts as no longer being fit for purpose.

In spite of this, a huge number of leases have been created with RPI linked ground rents or doubling ground rents, in order to appeal to investors or pension funds, looking for a safe and secure long term return for their money (pension funds in particular are massively exposed to any changes to ground rents brought in by the Leasehold and Freehold Reform Act 2024).

Whilst these financial mechanisms may be great for investors, they create real problems for the people that actual own and live in these flats. RPI ground rents can result in ground rents rising to levels that become unaffordable for leaseholders, potentially making it difficult for mortgage lenders to approve loans for properties with escalating ground rent clauses.

When ground rent is tied to the RPI, the rent increases with inflation, which can lead to unpredictable and significant cost rises. This creates a major concern for both leaseholders and lenders, as escalating ground rent can push the payments to an unaffordable level, creating financial instability. Lenders typically regard properties with escalating ground rents as high-risk if they are reviewed too frequently such as every five years, which may lead to difficulties securing a mortgage or refinancing.

Legal Implications of High Ground Rent: Housing Act 1988

Ground rent can become problematic under the Housing Act 1988 if it exceeds certain thresholds. Specifically, if the ground rent exceeds £250 per annum outside Greater London (or £1,000 in Greater London), the lease could fall under the provisions of the Housing Act, creating an "Assured Shorthold Tenancy" (AST).

This is particularly relevant for leaseholders with escalating ground rents that surpass these limits. An AST means that the landlord could potentially repossess the property if the leaseholder falls two or more months behind on ground rent payments. In such cases, the forfeiture provisions of the lease (which allow for termination of the lease) may become applicable, giving the freeholder greater power to terminate the lease.

Impact on Leaseholders and Mortgage Lenders

As ground rent payments rise, particularly with escalating ground rent clauses tied to RPI, the risk of arrears increases. If the ground rent exceeds £250 per year (or £1,000 in Greater London), mortgage lenders may view the property as a high-risk investment. In such cases, mortgage lenders may require the lease to be amended or "varied" to mitigate their risk. This is typically done by:

1. Deed of Variation: A legal document that can limit ground rent to £250 or less per year for the duration of the lease, or eliminate provisions that could lead to an Assured Shorthold Tenancy.

2. Indemnity Insurance: In some cases, lenders may accept indemnity insurance to protect against potential legal challenges, although not all lenders will accept this option.

3. Lease Extension: In certain situations, extending the lease may offer a solution to mitigate escalating ground rent issues by reducing the ground rent to a peppercorn, which will be much less offensive to mortgage lenders and purchasers.

Without a deed of variation or lease extension, some mortgage lenders may refuse to lend on a property with escalating ground rent clauses, especially if the ground rent exceeds the Housing Act thresholds. This can significantly impact the leaseholder's ability to secure financing or sell the property in the future.

The Importance of Lease Extensions in Managing Ground Rent

For leaseholders facing escalating ground rent, considering a lease extension is often a prudent option. A lease extension can reduce or eliminate the potential for escalating ground rent, fix the ground rent at a lower level, and provide greater stability for both the leaseholder and mortgage lender. By extending the lease, leaseholders can avoid the risks associated with escalating ground rent and the potential legal implications of the Housing Act 1988.

Conclusion

Escalating ground rent, especially RPI-linked ground rent, poses significant challenges for leaseholders, freeholders, and mortgage lenders alike. To protect against the risks associated with escalating ground rent, leaseholders should consider seeking a lease extension or negotiating a deed of variation to ensure that ground rent remains within acceptable limits.

Addressing escalating ground rent early can help avoid complications with property financing and prevent potential legal issues related to the Housing Act.