The Leasehold and Freehold Reform Bill: what it means for leaseholders and owners of mixed-use developments

The Leasehold and Freehold Reform Bill was introduced to Parliament on 27 November 2023 and is the latest manifestation of the government’s commitment to reform the residential leasehold sector.

The bill proposes long-term changes which aim to improve the experience of home ownership for millions of residential long leaseholders in England and Wales. The intention is to put freehold and leasehold owners on an equal footing, at least to the extent that is possible within the current system.

If enacted, the bill will make it easier and cheaper for leaseholders to extend their leases and to collectively acquire the freehold of their building. Whilst the reforms will be welcomed by leaseholders, they will be met with trepidation by many landlords, especially owners of mixed-use schemes.

Summary of the bill

The bill includes proposals to:

• Increase the "non-residential" limit in mixed-use properties for bringing collective enfranchisement and right to manage claims from 25% to 50%. This will substantially increase the number of buildings which are potentially subject to claims by leaseholders to acquire the freehold or take over management of the property.
   
• Increase the standard lease extension term to 990 years, up from 90 years for flats and 50 years for houses. This is designed to provide long-term security for leaseholders.
   
• Remove the requirement for a new leaseholder to have owned their house or flat for two years before being able to extend their lease. This change will increase the number of leaseholders who can exercise these rights and makes it possible for a leaseholder to buy a lease and immediately (once they have been registered as legal owner at the Land Registry) apply for an extension.        
   
• Eliminate "marriage value" from lease extension and collective enfranchisement valuations. At present, marriage value is part of the valuation formula for both types of claim and its removal will make claims more affordable. Marriage value is a tricky concept to understand but suffice to say it makes it more expensive to extend leases as they get closer to expiry, in particular where less than 80 years of the term remains.
   
• Extend leaseholders’ access to "redress" schemes. Freeholders who manage property will be required to belong to a redress scheme to ensure that leaseholders are readily able to challenge them for poor practice. In addition, the presumption that leaseholders should pay their freeholders’ legal costs when challenging poor practice will no longer apply.
   
• Provide for freehold homeowners on private estates to be given equivalent rights of redress as leaseholders. This will include requirements for greater transparency in estate service charges and the right for freehold homeowners to challenge unreasonable costs.
   
• Increase transparency in service charges. By requiring service charge bills to be issued in a standardised comparable format, leaseholders will be better equipped to scrutinise and challenge these demands.
   
• Replace buildings insurance commissions with transparent administration fees. The aim is to stop the practice of leaseholders being charged exorbitant commissions on top of their premiums.
   
• Supplement the measures brought in under the Building Safety Act 2022 (BSA). To ensure the BSA operates as intended with freeholders and developers being unable to escape their liabilities to fund building remediation work.
   
• No ban on leasehold houses (yet). However, the government has made repeated assertions that it will ban leasehold houses and it has promised amendments as the bill progresses to legislate for this.

How will these proposed changes impact owners of mixed-use schemes/developments?

Lease extension criteria

If landlords are required to grant 990 year lease extensions, instead of the current 50 or 90 years, it is self-evident that they will see a greater decrease in the value of their interest. Removal of the two-year ownership rule will increase the number of leaseholders eligible to claim an extension (although in practice this may not increase the number of claims, but rather bring forward claims that would have been made at some future date).  

Valuation

The changes to the valuation method, in particular the removal of the marriage value component, will make it cheaper for leaseholders to extend their lease or collectively acquire the freehold of their building. Freeholders will receive smaller premiums on a lease extension (at least comparative to the length of lease being granted) or sale of the freehold pursuant to a collective enfranchisement claim.

Higher "non-residential" limit of 50% for collective enfranchisement or right to manage claims

This change will bring all buildings where the internal floor area of the non-residential parts is 50% or less of the internal floor area of the whole building potentially within scope for tenants to make a claim to collectively buy the freehold or manage the building. As the current threshold is to double, there will be a sizeable increase in the number of mixed-use buildings potentially subject to these leaseholders' rights. This is understandably causing concern for landlords, not least because many mixed-use schemes were specifically designed to satisfy the existing 25% limit to put them outside the collective enfranchisement and right to manage regimes.

For owners and stakeholders of mixed-use developments, there are obvious potential pitfalls if leaseholders are successful in buying the freehold or taking control of managing the building. A group of residential leaseholders may not have the necessary expertise to run and manage a mixed-use building, particularly if it is a complex scheme, and this could negatively impact the value of the commercial interests in the building. For many looking to transact in such schemes, the assurance of freehold ownership and/or control of the building is essential, particularly in the case of potential funders and investors.

It should of course be noted that leaseholders will need to have in place the necessary funding if they want to buy the freehold of their buildings, which may not be a straightforward task where the building is substantial or a high-rise. Leaseholders may also be reluctant to tackle the complexities of owning or managing a mixed-use property, most notably the burdensome additional responsibilities which have come into force under the Building Safety Act 2022.

Whilst it is by no means certain that the bill will be passed in its current form, it would be wise for owners of mixed-use schemes to consider the proposals now to assess the likely risks associated with the potential reforms, particularly those relating to collective enfranchisement and right to manage claims. Prudent developers may want to review and modify proposed schemes to increase the proportion of commercial/non-residential floor area or alternatively let flats on ASTs or other short-term arrangements rather than long leases.

Proposal to cap ground rents

Alongside the draft bill, back in November 2023 the government launched a consultation seeking views on various options for limiting ground rents in residential long leases in England and Wales. The consultation closed on 17 January 2024. 

The proposals included the following options:

• Reducing ground rents to a peppercorn (i.e. zero)
• Freezing ground rents at their current level
• Capping ground rents at a percentage of the property value
• Capping ground rents at the level they were set at when the lease was granted
• Capping ground rents at a prescribed maximum level

The government has indicated that its preferred option is to reduce all ground rents to a peppercorn, which is the only option that will align all ground rents and ensure equal treatment with leases granted on or after 30 June 2022 (which are prohibited from charging ground rents of more than a peppercorn).

Whichever of these proposals is taken forward, if implemented, it will directly impact the investment income achievable from applicable leasehold properties. If the most radical option is chosen, to reduce all ground rents to a peppercorn, this will effectively nullify the return on investment for ground rent investors, many of which are large pension funds. Even bleaker for investors is the fact that there is no indication compensation will be paid in respect of their lost future income.

Unsurprisingly, these proposals are proving to be highly contentious and there will no doubt be further debate before a decision is reached. What is clear is that the government faces a difficult task in striking a balance between leaseholders' and landlords' rights.

Conclusion

The bill is an ambitious piece of legislation and is currently making its way through Parliament. There is clearly a long way to go before we can properly assess the full impact of the proposed changes. Given the government’s continued commitment to enhancing the rights of leaseholders and the Labour Party’s support for the measures in the bill, it is likely that the bill will be passed in some form, possibly as soon as during the course of this year.