I apologize that some of this information is complicated and difficult to follow but please bear with it because your freeholder trades on the fact that you probably won’t be able to understand it, so make sure you prove them wrong!
Informal or non-statutory lease extension are deals offered to you by your freeholder when you wish to extend your lease and they are designed, at first glance, to make it look like you are getting a deal!
Nothing could be further from the truth though. I call these informal offers ‘Trojan horse offers’. They look like a gift but when you look inside the details can be catastrophic.
The ancient city of Troy was under siege by the Greeks, and the siege had become a stalemate. The Greeks built a wooden horse and had some of its soldiers hide inside and pretended to leave. The inhabitants of Troy accepted the horse as a goodbye gift only to find that the soldiers sneaked out at night and let in the Greek army in and the city was lost.
This is a fair analogy of a freeholder’s informal offer, lets see why.
Your legal rights
If you have owned your flat for two or more years then you have a legal right to extend your lease by 90 years and reduce the ground rent to zero.
How to value a lease extension
The law says that you must compensate your freeholder three different ways when you extend your lease (or purchase your freehold)
- Ground Rent
This is the amount of ground rent you owe your freeholder in total for the remaining years of your lease, but calculated in today’s money;
This is the amount you would have to give your freeholder as a lump sum, so that they could invest for the remaining years of your lease (with an equivalent compound interest rate of, say, 5%), that would be worth the value of your flat – with a long lease – today;
- Marriage Value
This only applies if your lease has fallen below 80 years. If you extend your lease, the value of your flat will rise. The rise in value must be calculated and the total ground rent and reversion due subtracted.
Whatever is left is then split 50/50 between you and your freeholder.
In this blog I am going to use real figures from a flat I recently worked on and are going to use these figures as method of seeing the real implications of an informal lease extension.
The details of the informal are also real from a large, immoral, London based freeholder.
Our example is A1 Nice flat in London
- The value of the flat with a long lease of 99 years £230,000.00
- Ground rent £75.00 per year doubling every 33 years.
- Current lease length 75 years.
The valuer recommends the following:
- Ground rent total £2,143.00
- Reversion total £5,849.00
- Marriage value total £1,754.00
Total for lease extension £9,746.00
Add the total fees on top of this of £3,500.00
Total price £13,250
If you extended your lease using your statutory legal right then your lease would be 165 years with zero ground rent. The lease would not need extending for another 85 years and even then it would be very cheap as there is no longer a ground rent element to include in the calculation.
The lease length issues of your flat have been rectified once and for all and there would be no future value in your flat for your freeholder.
Your statutory lease extension from your freeholder’s point of view.
They bought the freehold of your building to make as much money as they possibly can from each flat.
They make money the following ways:
- From immoral licensing fees hidden in the terms of your lease.
- By ripping you off by claiming a ‘finders fee’ they get back from your building insurance, which you have no choice but to pay them for.
- By syphoning off service charge fees.
- From the ground rent you pay to them each year.
- The money you have to pay them for a lease extension.
You extending your lease is the big pay day for them and if they can fool you into accepting an informal lease extension it will turn into tens of thousands of pounds for them. If, however, you extend your lease by an additional 90 years and reduce the ground rent to zero, this basically wipes out all the future profit they will receive from your flat.
They really do not want you to do this.
They want you to accept their ‘Trojan’ lease extension deal.
What does an informal lease extension look like?
I would like to state, emphatically, for the record that you do NOT have a legal right for an informal lease extension. Please bear this in mind, we will return to this many time in the rest of this examination.
There is another way you can extend your lease and that is by contacting your freeholder directly (or many times they will contact you) as soon as they are aware you want to extend your lease.
Below is an informal lease extension offer from the freeholder for this flat.
Dear Mr and Mrs Naive
We are happy to offer to extend your lease back up to 99 years for the inclusive price of £10,200 and our total legal and valuation fees will be an additional £1,000 pus VAT.
The ground rent will be £250 a year doubling every 10 years.
We will are not looking to amend your lease in any way, we will only modernise the terms of your lease. We are able to complete this process in two months.
This offer is valid for thirty days from the date on this letter.
What this offer looks like at first glance
Wow, it appears that the freeholder is a nice guy after all! The total price he is offering is £10,200 plus fees of £1,200 (Total £11,400) saving you £1,850 pounds to extend your lease back up to 99 years.
Ground rent is just £5 per week and they only want to modernise the terms of your lease.
They will complete this whole thing in three months (instead of a year if you extend using your statutory rights) This is brilliant, “Where do I sign?”
That’s why I call these offer Trojan offers, because the devil is in the detail.
Let’s examine this offer more closely.
The term of the lease extension
The freeholder generally offers to extend your lease back up to 99 years and this seems like more than enough for most flat owners.
There is a very real reason freeholders only offer an extension back up to 99 years and that is because in 17 years or so, someone is going to have to extend the lease of the flat again.
As we will show later in this blog, the details of the informal offer they have offered here means that whoever is unfortunate enough to own this flat when the lease needs extending again in 17 years, is going to have to pay an absolute fortune for the privilege.
Beware of another trick the freeholder does regarding the term of the lease, they may offer you a 125 year lease extension which seems like it could be a much better deal for the flat owner.
They omit to mention that the 125 year extension starts from when the lease was originally granted NOT your 74 year lease extended up to 125 years!
If you are unhappy with this, you have no legal recourse to argue with your freeholder. You do not have a legal right for an informal lease extension it is a take it or leave it deal.
The future implications of ground rent
£250 a year doubling every 10 years does not sound like a lot of money, but it is.
A ground rent schedule like this is considered an onerous ground rent schedule, which could easily affect the future salability and value of the flat. This is because the freeholder is going to make money two different ways from this increased ground rent.
Firstly, the ground rent he will get extra before someone extends the lease on the flat again. If the ground rent is £250 per year, then the freeholder will make £2,500 extra that he would not have if the flat owner had used their statutory rights for the next ten years and then it doubles, then doubles again and again.
That’s not the big money for the freeholder though. The big money comes from the fact that someone is going to have to extend the lease on the flat again, only now, instead of the ground rent being £70 a year like it is now. The ground rent is now £1,000 a year!
So how much will the freeholder make over the next 24 years because they tricked the flat owner into the informal offer?
- Cost of the lease extension = £10,400
- Legal fees = £1,200
- 10 years @ £250 ground rent = £2,500
- 10 years @£500 ground rent = £5,000
- 6 years @£1,000 ground rent = £6,000
- Cost of the lease extension = £76,500
- Plus legal fees @ £2,000 =£2,000
Total received by your freeholder over 24 years = £103,600
Compare this to the £13,250 you would have spent to extend your lease for an additional 90 years with zero ground rent forever more.
The initial saving of £1,850 your freeholder waved under your nose has turned into £90,000 profit for him, not a bad business being a freeholder is it?
Just to be very clear, when a freeholder increases the ground rent he makes money two different ways, the actual ground rent he collects each year and the future value of a lease extension with an onerous ground rent clause.
A future freehold purchase
Another ploy by predatory freeholders is to offer informal lease extensions to flat owners when they know they are going to sell the freehold of the building. They offer an informal and you pay them £10,200. A year later they offer to sell you the freehold of your building. How do you calculate your share of the freehold purchase?
You have to calculate the ground rent and reversion elements we talked about at the start of this blog but your ground rent is now huge and doubling every 10 years. You will end up paying more than £10,200 to purchase your share of the freehold!
Note: If you had extended using your statutory rights your there is zero ground rent, no marriage value as your lease is 165 years, so the only calculation is reversion but this is over 165 years. It would cost you about £250 to buy your share of the freehold!
There are also much worse offers you will need to watch out for with the ground rent. Here are some I see every day.
Onerous GR clauses
Freeholders will often ask for £250 a year rent, doubling every 10 years linked to RPI. RPI stand for the Retail Prices Index, which is used to measure inflation. Obviously no one knows what inflation will be in the future but one thing that is sure is that it will cost you dearly.
Not only will your ground rent double in ten years, someone will calculate what has happened to RPI over the last ten years and add it to your doubled ground rent!
Capital Value of flat
Freeholders will often ask for £250 a year rent, doubling every 10 years linked to 0.025% of the capital value of your flat.
After ten years not only will your ground rent double, your ground rent will then be linked to the actual value of your property!
Capital Value of the estate
Some of the estates in London have ground rent doubling every 10 years linked to 0.025% of the capital value of the estate, not just your flat!
Doubling every five years
We see more and more freeholders trying to fool people into signing informals where the ground rent doubles every five years.
This is just ridiculously onerous! Taking any of these deals could leave you owing a flat that no one wants to buy (except, of course, your freeholder who will be happy to buy it for a knock down price).
I worked out what effect this would have on a flat with a 999-year lease we worked on recently in Islington. The ground rent was £250 a year doubling every 25 years.
We worked out for the last 25 years of the lease the ground rent would be £165,000,000,000.00 per year! It is not just the future implications of the ground rent that you need to look out for if you are considering taking an informal (although that should be enough!).
Let’s look at the other areas we need to be aware of.
The terms of your lease
If you extend your lease using your statutory legal right, you are protected by law and your freeholder cannot alter the existing terms of your lease.
If you take up your freeholders offer of an informal lease extension you are not protected and your freeholder can make any changes he wishes.
‘Wait!’ you may cry ‘In the offer letter from the freeholder they state that they will not alter any terms of my lease, they will just modernise them!’
It does say that in the freeholders offer but in reality, what does the word ‘modernise’ mean?
I can tell you categorically that the word ‘modernise’ means whatever terms can be changed to benefit your freeholder. I see this every single day in my office.
It may be worth pointing out at this point that the saving your freeholder is offering you in this informal deal come from the fact that you will have no legal representation through this process.
They are telling you to not to have a lawyer protecting your interest through this process and they are then presenting this fact to you as if they are saving you money! Genius isn’t it?
The truth is though, there is no point in having a solicitor represent you in an informal as you do not have a legal right for it. It is a ‘take it or leave it’ offer so even if you find something you are unhappy about, there is no legal mechanism for you to remove it.
So what are the terms of the lease the freeholder is keen to change?
Put simply, anything that makes them more money and protects their position as your freeholder.
They will insert additional licenses that mean you have to pay them to alter your flat, sell it, rent it out, renew the rental contract each year with your tenant, get cable TV, turn over to your left side in bed at night etc.
I spoke at a block of flats a couple of years ago at some flats close to West Ham tube station. One chap in the audience thought I was exaggerating the issues of informal lease extensions and he went direct to his freeholder for a flat he rented out.
He phoned me a few months later to say that his freeholder had instead added a clause in his lease, which said that he would have to pay the freeholder 10% of the rental income he receives each month, forever more. The chap wanted to know what he could do about this clause as he had signed it a couple of months before and were now chasing him for the money!
Some of the clauses of the lease the change could also have serious implications for the security of your flat and increase the freeholder trying to get forfeiture of your flat (which they love).
They may insert a clause in your lease, which says that if you ever take them to court, for whatever reason (even if your freeholder was caught committing service charge fraud) that the freeholder’s full legal fees can be reclaimed from you by way of the service charge.
If you sign the new lease, with these terms it is now your reality and you can’t alter it.
Be very, very careful regarding the terms of a lease and remember that even if you find bad ones your freeholder has tried to insert, there is absolutely nothing you can do to remove them.
The other area to keep an eye on is timescales. You do not have a legal right for an informal lease extension and your freeholder can withdraw this offer whenever he wants, with no legal recourse at all.
Why would they do this?
There are many reasons a freeholder would withdraw an offer, but it’s always so they get more money from you. For example, if you were selling your flat and you have a buyer lined up and it all hinged on this lease extension, your freeholder may withdraw their offer claiming there was a mistake on the valuation and they now want £1,800 more.
Chances are you will just pay it!
Freeholders often do this when your flat lease length is about to go below the pivotal 80-year mark. The freeholder offers what appear to be good informal offers.
Your flat has now gone below 80 years and your freeholder’s investment has risen by thousands of pounds per flat. There is nothing you can do about it either.
I have lost count of the amount of times I have heard freeholder’s solicitors bragging about doing this to flat owners.
If you extend your lease using your statutory rights there are strict timescales that your freeholder must abide by.
I am shocked by how many professionals recommend that their clients accept informal lease extension without pointing out any of the above.
The big excuse used by all the professionals who recommend that their clients accept informal offers is ‘Why are you worried about the details, let the person who buys your flat worry. You save £1,800 that all you should care about. Caveat emptor!’
If a solicitor or valuer quotes you to extend their lease they have a year long battle with a knowing freeholder before they get their money. Obviously, if an informal lease extension offer is accepted they get their money very quickly with little work which is why few professionals point out all the problems I have in this blog.
Also, maybe five years ago this argument of ‘let someone else worry about the details’ may have been true, but it’s not a fair argument anymore.
More and more flat owners and solicitors are looking at the details of informal lease extensions and onerous terms inserted in the lease.
We see so many flat sales fall through now because someone has understood the implications of the informal lease extension offered.
Banks and building societies are also understanding the implications of onerous informal deals and the future effects these have on the value of flats.
In the big mortgage shake up of April 2014, the Council of Mortgage lenders brought in more stringent tests for people wishing to get a mortgage. This also included looking at the details of a flat sale.
In fact, the Halifax building society has already stated that they will take not grant a mortgage on any flat where the ground rent doubles every ten years. What about future legislation changes which could highlight these informals even more thus raising customer awareness to it?
Maybe the people buying your flat won’t understand the future implications of what you have signed up to in your informal deal with the freeholder, but is it really worth taking the chance to save a few hundred pounds in the short term?
How would it affect your future plans if you were stuck with a flat that you couldn’t sell?
Conclusion Why shouldn’t you accept an informal lease extension from your freeholder?
- It will commit the flat to an additional £100,000 needless spend over the next couple of decades.
- It means that this flat will have to spend a disproportionate amount to extend the lease in the future.
- It would also cost a fortune for this flat to take part in a future freehold acquisition.
- You will undoubtedly sign up your flat to lots of unsavory new lease terms.
- You could massively damage the future resale value of your flat.
- You could end up with a flat no one will buy.
The ‘Trojan horse offer’ of an informal lease extension really does contain lots of nasty details inside.
Details that can have very long term repercussions for this flat and whoever is unfortunate enough to own it. Most freeholders are professional freeholders and by and large they are not your friend. They own the freehold of your flat for one reason only and that it to make as much money as they possibly can.
You have no reason to ever trust them and I implore you to never trust them.
“Beware of freeholders, even those bearing gifts”
©Barcode1966 – 2015