Leasehold Reform (Ground Rent) Act 2022 - A potential split in the ground (Rent)?

The Leasehold Reform (Ground Rent) Act 2022 (the "Act") received Royal Assent on 8 February 2022 but the substantive provisions are not yet in force.  They are due to come into force on 30 June 2022 (for the majority of leasehold properties). This is the first major piece of legislation in leasehold reforms which will cover a raft of proposals aimed at making leaseholds fairer for residential tenants. 

Reduction of ground rent to 'zero'

Whilst a proposed amendment to remove ground rent under existing leases was resisted, the Act will limit the ground rent chargeable to one peppercorn per year for most new long residential leasesentered into after the provisions of the Act come into force (other than leases pursuant to a contract entered before that date).  This will effectively restrict ground rents to zero financial value. 

The Act enforces the ban on ground rent by making it unlawful to require a tenant to make a payment of prohibited rent (being any rent which exceeds the permitted rent of a peppercorn) or not to reimburse the tenant with any payment received within 28 days commencing on the day after receipt. This operates in a similar way to the provisions limiting certain fees on short leaseholds under the Tenant Fees Act 2019. The local weights and measures authority will enforce the Act and may impose financial penalties between £500 and £30,000 (some might say, incentivising the enforcement of these rules!).

It is worth noting that helpfully, the Act makes it clear that a sum expressed to be payable in respect of rates, council tax, services, repairs, maintenance, insurance, or other ancillary matters will not be treated as 'rent' for the purposes of the Act merely because it is reserved as rent in the lease. 

What about existing leases?

As the Act only relates to new leases granted after it comes into force, at present it provides limited help to existing leaseholders whose leases require payment of ground rent.  The solution for some tenants of existing leases, if they would like to take advantage of the new legislation, could be to seek an agreed extension of the lease term by way of variation which would be classed as a new lease under the Act and so subject to the maximum ground rent of a peppercorn.  Whilst leaseholders could attempt this, the Act is slightly contradictory as it also permits ground rent to be charged in such circumstances (where there has been a deemed surrender and re-grant) but only up to the expiry of the original term for the lease granted before the Act is in force.  On this basis, a well advised Landlord may be inclined to resist this proposal in the first instance.  However, given the potential for reform to deal with ground rent in existing leases, there may be merit in a landlord agreeing such an arrangement because the ground rent will then be limited to a peppercorn before any further legislation takes effect, providing certainty.  It is clear that both parties should take careful valuation and legal advice as to the merits of each option!

The government has previously indicated that it will also remove ground rents for existing leases but has not yet legislated for this.  Whilst we can at this stage only speculate, it seems logical that any retrospective effect could extend to reimbursement of all ground rents that were charged for any lease commencing after the Act received Royal Assent. If so, this would have a significant impact on cash flow where developers are required to fund reimbursement of ground rent on a large scale. 

A split development?

At present ground rent leases (and contracts to grant them) can continue to be entered into until the legislation comes into force.  As there are no transitional provisions to deal with this issue, it is conceivable that a development could have a mixture of leases granted before and after the Act comes into force with the result being that those granted before, could be subject to a ground rent and those granted after (where there is no pre-existing lease) could not. 

Developers should be aware that to continue to include ground rent in leases entered into before the Act comes into force would likely be considered outside the spirit of the legislation given the move towards reform in this area on a far wider scale and might well fall foul of future legislative changes.   With this in mind, they should think carefully about the approach to be taken at the outset of any development.   A development split in this way could also give rise to several issues including a potential shortfall in overall expected ground rents, difficulty financing leases with ground rents in a two-tier market (essentially rendering some properties unsaleable) and a valuation discrepancy between the two types of lease. 

Finally, it cannot be overlooked that this situation has the strong potential to create a two-tier market where new leases (with zero ground rent) will be more attractive than those granted prior to the substantive provisions of the Act coming into force.  This means that whilst developers may seek to benefit from the additional income stream from ground rents while they can, they should also consider the potential implications for saleability, reputation and also certainty moving forwards.  If you would like to discuss issues concerning ground rents on your development, please get in touch with one of our experts below.