After meeting with a prospective landlord last night we started to discuss his feelings to purchase either a leasehold or freehold property. So i thought I’ll write today’s blog on what we discussed:
In general terms, there are three forms of legal ownership of property in the UK:
- Freehold, where you own the land and have control over the building
- Share of freehold, where you own a share of the freehold and can influence decisions of what happens to the building
- Leasehold, where you own a lease that gives you permission to occupy the property for a certain period; a freeholder retains ownership of the land.
The majority of flats and maisonettes in the UK are sold on a leasehold basis. For houses, freehold has been the traditional type of tenure (although this is beginning to change, with registrations of new build leasehold detached houses more than doubling in 2015).
So when you’re looking for properties that would make a good buy-to-let investment, does it matter what kind of ownership you look at?
From the perspective of a landlord looking for a low-risk investment property to own and tenant for the long term, leasehold properties have different issues to freehold properties, which all landlords need to be aware of.
I have always been a fan of freehold over leasehold for a number of reasons.
- Leasehold means service charges and ground rents…
…which can significantly bite into your cash flow. How much? It depends on the contract with the freeholder. It might add up to less than £100 a year but you need to check it because sometimes it can be many hundreds or even thousands of pounds.
- Leasehold means that you will never own the property, only the lease.
Is this just a legal distinction? No – it effectively means you, the landlord, also have a landlord – with all the issues in the points to follow. Also, bear in mind the freehold can be sold to the highest bidder.
- Leasehold means being restricted in what you can do with the property
You cannot develop the property on your own initiative, therefore it is harder for you to add value and grow your investment that way.
- Leasehold means being beholden to a freeholder and their demands.
Your landlord can recover unpaid ground rent going back 6 years – they can even ask you for the full amount in one go. You will probably have to pay maintenance charges – which you might find excessive, given the quantity and quality of the work they carry out. Or when major building works are required, perhaps the price you’re paying includes an over-generous “management fee” for the freeholder.
Some freeholders are reasonable in their demands, but by no means all of them.
- Declining lease lengths can cause the property to decline in value.
The market value of your leasehold property depends on the length of the remaining lease.
It drops in value sharply when the lease length goes below 80 years (more detail in the next two points). Really, to preserve the value of your investment, you would want to avoid the lease going below the 90-year mark during your ownership.
- It can be expensive to extend a lease.
The cost levied by the freeholder to extend the lease depends on how many years are left to run, and could leave you looking at a significant outlay (take for example: the £13,000 fees being asked of homeowners in Cramlington, Northumberland). Also in most cases you would need to own the property for two years before you earn the right to extend the lease.
- Mortgage lenders generally prefer freehold to leasehold
If you are funding your investment with a buy-to-let mortgage you may find it difficult to get finance for a property with a shorter lease.
The exact threshold varies from lender to lender but in general, finance companies are reluctant to lend on a property with a lease shorter than 70 or 80 years
- Disputes can often arise between leaseholders and the freeholder.
Buying a leasehold property means entering a relationship. Just like any other relationship, it can be good or bad. Some freeholders are reasonable. Some reach aggressively for lawyers. And some seemingly cannot be contacted at all – see the next point…
- If the freeholder disappears, it can be a nightmare scenario to resolve.
“Absent freeholder” can be a real problem – just see the number of threads about this.
It means you’re legally bound to a relationship with an entity you don’t know and aren’t able to contact. Although in some ways this can mean a nice quiet life for a while, it can pose significant problems when it comes to buying and selling, particularly where mortgage lenders are concerned.
- Leasehold can mean depending on other leaseholders, too
Just as leasehold puts you in a relationship with a freeholder, buying a leasehold flat means you are potentially affected by the actions of other owners on the same building or plot. You have a commercial dependence with other leaseholders to pay their service charges. If they don’t, the whole plot or building could suffer.
- You depend on the freeholder for building maintenance
If the freeholder does not maintain the building to a high standard, the value of your property can be affected. As a leaseholder, you depend on the freeholder acting in your mutual best interests. As you can deduce from some of the points above, this is by no means guaranteed.
One more reason to consider freehold over leasehold…
With the sharp increase in leasehold new build houses that we’re seeing at the moment, freehold homes are becoming (relatively) scarcer. I believe that where there is scarcity, there is value – therefore freehold houses will command a premium in the future.
To my mind, landlords should now be looking to secure freehold houses. I believe that they will have better capital appreciation because they will be more desirable in the future.
So which type of ownership should you favour for buy-to-let?
As a landlord, it is vital to understand the differences between leasehold and freehold from a cash flow perspective, a future value perspective, and a “desirability” perspective.
If you want to discuss any leasehold or freehold opportunities and would like a second opinion, i would be happy to discuss !!!