Leasehold vs Freehold: Which is Better?
When it comes to choosing between a leasehold vs. a freehold, it’s a tricky choice
On one hand, as a leaseholder you get the benefit of not having any irritating property maintenance to deal with and can focus solely on what’s inside the four walls of your property.
On the other hand, as a freeholder, you are captain of your own ship, answerable to nobody (except all the usual suspects!) and free to do what you want, when you want (again, within reason – you are still a landlord and therefore bound by legislation in spades).
However, with over 222% of residential property transaction in in 2019 sold as leasehold, with almost all flats sold under this basis and 8% of houses, for many landlords looking to invest, it’s not a decision you’ll get to make – it’s leasehold or bust.
We caught up with Adrian McClinton, Property Litigation Solicitor and Head of Dispute Resolution to get the low-down on leaseholds, and understand a little more about how they work for landlords.
What’s the big difference between leaseholds and freeholds?
Before we get into the nitty gritty, let’s define exactly what we’re talking about. What exactly is the difference between a leasehold property and a freehold property?
‘If you own a property freehold, you own the land on which that property is situated’, explained Adrian. ‘If you own a property that is subject to a lease, you own the leasehold interest that is derived from that freehold.’
So, if you own a property that is subject to a lease, you own the bricks and mortar property, but are essentially renting the land that it stands on for the period of time outlined in the lease?
What do you tend to find is that the type of lease that you’ve got is what’s known as an eggshell lease. You own the inner part of that property, and then outside of that is the under the ownership of the freeholder.
How does that work for landlords then?
‘I think it’s important to understand that there’s no legal distinction between the term leaseholder and tenant. So effectively, if you’re a leaseholder, you are a tenant. That tends to be the term leaseholders use when we’re describing in residential terms, a long leaseholder, someone who has a tenancy for a long period of time.’
So, by letting your leasehold property you are effectively subletting to your tenant?
‘Yes. The sub-tenancy, more often not an Assured Shorthold Tenancy is derived from your legal interest as a leaseholder.’
Ticking time tenancies
I’m sure we are all aware that leases have a shelf life and have probably all seen property adverts that appear to be an absolute bargain… until you realise that the bargain buy has a frighteningly short lease left, which will cost a fortune to extend.
Is it always the case that the longer the lease, the more secure the asset?
Yes, that’s correct. It’s a depleting asset. The length of your lease will sometimes determine the value of the leasehold interest. It’s important to remember that after a certain number of years, it can be more expensive to extend your lease. If the lease is below a certain number of years, it’s difficult to get a mortgage on the lease.
‘That can also limit the market in which you could sell your leasehold interest to sell the property. It becomes a live issue for a lot of leaseholders when it’s approaching 80 years left to run. The reason being is that if you want to extend your lease it becomes more expensive effectively to extend your lease.’
If you have a lease that’s creeping down to the 80-year mark, should you be thinking about acting, or is it a problem that can be ignored?
‘Yes, you do need to act!’ stressed Adrian. ‘If the lease is under 80 years, it will result in you paying a higher premium to the freeholder or your landlord to extend the lease. It also means that if you sell the property it might be harder for any potential buyer to obtain a mortgage. And it can get to a point where if the leases have particularly short length, that the only parties that could buy the leasehold interest would be cash buyers’.
Extending a lease
If a lease is for all intents and purposes a really lengthy tenancy agreement, how complicated is the process for extending one? Is it just a case of agreeing it with the freeholder of ‘landlord’ and signing some more paperwork, or is there more to it than that?
‘You can do it informally with your landlord’, said Adrian. ‘You can approach them and ask them if they want to extend the lease, some landlords are interested in that. If you can’t reach an informal agreement with your landlord, there is legislation that enables a lease holder to compel the landlord to grant them a new lease for a period for a longer period of time’.
And is that process costly? Sounds like the informal route could be kept relatively low key, but the formal route (let’s be honest, anything involving legislation tends to hit a landlord in the wallet) might rack up the costs?
‘There are so many factors that go into how much you pay by way of premium to extend your lease’, said Adrian. ‘The length of the lease, the ground rent that’s payable under the term of the lease, the location of the property as well. As you can imagine, a property that’s located in Mayfair will be of more value and therefore be more expensive to extend a lease on than a property that’s located on the Old Kent Road’.
Ok, so say you have the aforementioned property in Mayfair. And it’s looking mighty costly to extend the lease. What’s the worst-case scenario if you buried your head in the sand and just didn’t?
If you sell the property, you’d be very limited to a certain type of buyer, so that might be one reason. Another reason is just protection of your asset, as the asset depletes, it becomes less valuable.
We’re getting used to saying this, but there are changes afoot in the legislation surrounding leasehold laws. What’s being proposed, and how are the suggested changes going to impact landlords moving forwards?
‘Well, there’s a lot of uncertainty as to how the enfranchisement landscape is going to change’, said Adrian.
‘The Law Commission produced a report back in 2020 with 102 proposals and the government has stated that it is going to bring in legislation that addresses some of those proposals. For instance, the abolition of sky-high ground rent, the abolition of something called marriage value, making it easier to extend your lease and making the process easier’.
‘But, there haven’t actually been any draft bills put in front of the commons yet. Michael Gove has made it clear that he wants to start within this Parliament, which will likely come to an end in May 2024. But, we’ve been waiting for years for reform of this area of law’.
If a landlord has a lease creeping down, say they’re at 85 years, is it worth holding out and hoping Mr Gove gets his way and the legislation kicks in and is more in their favour? Or should they still act now?
‘I think it really does depend on your individual circumstances and what you want to do medium to long term with that property,’ explained Adrian.
If you’re approaching 80 years, you might actually think it’s probably best to extend, so you don’t go under that threshold of 80 years and have to pay additional premium to the landlord. If, for instance, you have a lease that’s got 100 years, I might say to leave it because that lease will be attractive to any potential buyer.
Causes for concern
Short leases aren’t the only headache that landlords can find themselves facing though. Many people contact us with questions about common areas, and who has the responsibility for the maintenance of them. What’s the deal with those?
‘More often not that will be the freeholder on your head landlord. Your lease will make clear what your landlord’s obligations are’, said Adrian. ‘Normally it will be to keep and repair the common area, keep it tidy in return for payment service charges, normally it will be made clear within a lease’.
So, as the leaseholder, if your tenant is upset and feeding issues back to you about common areas, the landlord has the responsibility to escalate those issues to the freeholder or the building’s owner to make sure they sort out those common areas.
Collective enfranchisement and right to manage are terms that crops up within conversations about leases, and many of us don’t really understand. But it’s something that really can be useful isn’t it? Can you explain it a little more?
Within the same legislation that enables a leaseholder to compel the landlord to grant them a new lease, is also the ability for leaseholders to club together and compel the freeholder to sell to them the freehold interest of the property.
‘The most common reason for this is when the leaseholders feel that they want to take back control of the running of the freehold. In fact, a lot of the cases involving collective enfranchisement involve situations where there was an absentee freeholder, and the freehold itself was not being run properly’.
How does it work in practice? If you have a large block of flats with, say, 100 leaseholders within that, getting all of them to agree to a collective enfranchisement is going to be a really complicated process, surely?
‘It will be. The less leaseholders there are, the easier it will be’, agreed Adrian. ‘There is a threshold, it’s got to be over 50% of the leaseholders want to exercise the right’.
What are the benefits of collective enfranchisement?
Well, so far it doesn’t sound like there are a huge number of benefits to leaseholds, it must be said. They sound like costly headaches, in all honesty. But surely, there must be plus points, right?
‘Well, one of one of the things that happens when leaseholders get together to exercise the right to collectively enfranchise purchase the freeholders that they soon realise that more often than not, they don’t like each other, and they find it difficult to run the freehold and make decisions that that are in the best interest of the freehold assets’, laughed Adrian.
‘You can have squabbles, you can have periods where decisions cannot be made. Whereas if you have an arm’s length freeholder, they’re running the freehold and their obligations to the leaseholders mean they can determine when works to be carried out, and they can point to the lease as their right to do that’.
So, for all intents and purposes a freeholder acts as a referee, acting as an impartial third party whose only interest is in the building, rather than the ins and outs of those with a financial interest in it?
‘The referee can act as an honest broker,’ said Adrian. ‘They have obligations that they need to comply with under the terms of each individual lease so it’s easy for the freeholders to say we have to carry out this work, we’re obligated to do so, and the work needs to be done’.
Steer clear of leases or full steam ahead?
All things considered, if you are looking to invest in property right now, should you be looking to avoid leasehold properties (until legislation changes) or is it still a safe bet?
‘Leasehold ownership is a very common form of ownership. It’s been around for many years. It’s clearly in need of reform, but it is a very efficient way to manage large amounts of property’, stressed Adrian.
I don’t think that investors should shy away from leasehold property specifically, but they do need to understand that there are limitations in terms of ownership, and there are things that they need to do to protect their asset.
So, proceed, but with advice, and caution?
‘Yes. That advice will come from a number of different quarters. A lawyer will be able to advise you on the legal aspects of this. But if you were to extend your lease, you’d need the assistance of a specialist valuer who is used to working in this area because it is quite specific’.