Page last updated at 23:30 GMT, Tuesday, 29 December 2009

Why flat owners should extend or buy their leases

Money Talk
By Richard Meeson
Carter Jonas property consultants

Block of flats in London
Short leases are bad for flat owners

Flat owners in England and Wales who lease their properties need to get to grips with two things that could otherwise result in considerable financial pain.

They go under the names of "leasehold enfranchisement" and "leasehold extension".

Many leases on flats built in the 1960s, 70s and 80s are getting close to a critical stage in their lifespan.

Flat owners who want to extend their leases, but wait too long, could see the price for doing so rise sharply.

But let us not get ahead of ourselves - what do the two terms mean?

Definitions

Leasehold extension is fairly self-explanatory.

Any property owner with an unexpired term of just above 80 years should act without delay

It is the process of extending a lease on a property by paying the landlord, or freeholder, a sum of money - sometimes referred to as compensation.

Leasehold enfranchisement is not so self-explanatory.

It is the process of buying the freehold from the landlord and thereby turning your leasehold property, in which you are the tenant, into a freehold property.

You become the freeholder and own the property and the land on which it is built outright.

A lease, for the record, is a contract allowing you to occupy a property during a pre-agreed period in exchange for a pre-agreed rent.

Leases on flats are generally between 99 and 125 years.

Right to extend or buy

So what options are open to people who lease their flats?

Well, they can choose to individually extend their lease.

To do this, however, they must have owned, but not necessarily lived in, the property for at least two years.

A lease extension is achieved by granting a new lease in place of the existing one, but for 90 years longer.

An advantage is that the original ground rent will be reduced to a peppercorn, or nominal, ground rent.

This is involved purely to show that the property is still leasehold rather than freehold.

Tenants in a block of flats can club together to buy the freehold - this is referred to as collective enfranchisement.

For a collective enfranchisement, at least 50% of flat owners need to co-operate, although the two-year ownership requirement does not apply.

The advantage of enfranchising a block of flats is that the flat owners themselves can have more control over how the block is managed and other relevant costs.

This can be very important if the block of flats you live in is being poorly managed.

Why extend now?

Many flats built in the 60s, 70s and 80s came with 99-year leases.

Richard Meeson
Richard Meeson of Carter Jonas

These properties now have unexpired terms of only 50-80 years and will be difficult to sell or mortgage.

They will also be worth a lot less than those with long leases or freeholds.

Properties with leases under 70 years can be particularly difficult to sell, because mortgage lenders generally do not like to lend on flats with short leases, as they do not provide them with enough security.

It is therefore very important for owners of such flats to exercise their right to extend their leases, especially if they are thinking of selling later.

Also, if the unexpired term is 80 years or less, the premium payable can be much higher.

The law says that 50% of what is known as a "marriage value" needs to be paid as part of the compensation to the freeholder.

The marriage value is the amount by which the value of the house or flat will increase once the lease has been extended.

So any property owner with an unexpired term of just above 80 years should act without delay to avoid paying a marriage value.

House price dependent

Another reason to extend now is that the compensation payable to the freeholder relates to the current value of a flat.

Property values as a whole have fallen in the past two years and are still lower than 2007 levels, despite recent price rises.

The process of lease extension can take a few months, so it is also worth starting early so that it can be concluded well before you want to sell or re-mortgage a flat.

Note, too, that the tenant has to pay the landlord's valuation and legal costs.

Because of this, anyone wishing to acquire their freehold or extend their lease should seek specific professional legal and valuation advice.

How much does it cost?

The law sets out how much compensation has to be paid to the landlord when you extend or enfranchise your lease.

For flat owners up and down the country, a bit of short-term pain will result in long-term gain

Key determinants include:

• the value of the landlord's interest, namely the present value of the right to receive the existing ground rent until the end of the lease term

• the present value of the landlord's right to get the flat back at the end of the lease with vacant possession - known as the "reversion".

As we have seen above, if the lease is less than 80 years the tenant will also be required to pay 50% of the marriage value to the freeholder.

Essentially, the shorter the unexpired term the higher the reversion, and on leases below 80 years a marriage value is applicable.

In short, the longer you delay extending your lease, the more it will cost.

For example, take a two-bedroomed flat built in the 1970s or 80s, held on a 99-year lease, paying £50 ground rent per year and having a market value of £250,000.

Assuming an unexpired term on the lease of 80 years, the premium for a lease extension might be about £6,000.

However, with an unexpired term of 70 years, the cost of the lease extension would be about £16,000.

For flat owners up and down the country, a bit of short-term pain will result in long-term gain.

The opinions expressed are those of the author and are not held by the BBC unless specifically stated. The material is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Links to external sites are for information only and do not constitute endorsement. Always obtain independent, professional advice for your own particular situation.


Update 12 November 2010: This article was the subject of a complaint to the BBC Trust. You can read details of the finding here.



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