The new risk area for residential valuers
Is it a short lease? Is it an H.M.O? No it’s an escalating ground rent! Seemingly, the new buzz phrase in the residential valuation industry! Escalating ground rents appear to be the new risk area for residential valuers.
Whilst escalating ground rents have been around for some time, and it’s not uncommon to see a ground rent rise from for example £25 to £75 or £50 to £100, more recently we have seen cases of rapidly escalating ground rents. These can range, with some formula based linked to retail price index, or perhaps of more concern, where the ground rent increases to a percentage of the market value or rental value of the property, or those which double every 5 or 10 years.
Where escalating ground rents are onerous, this may have an impact on the marketability and/or mortgageability of the property. As a minimum there is resultant increase in the premium payable for a lease extension or freehold purchase where the capitalisation of the ground rent is factored in to the premium, or in more extreme cases the ground rents become so unaffordable that the leaseholders default leading to court proceedings and potential forfeiture of the lease.
These are often being seen on new builds or second hand resales where the original purchase date was 2006/2007 and the first review will be due now where the escalation is every ten years. A couple of well documented cases include: a leasehold flat purchased at £169,000 on a 125-year lease with ground rent of £250 that was seen to double at 10 yearly intervals for the duration of the term resulting in a ground rent of £512,000 in the final decade of the lease; or a leasehold house purchased 20 years ago for £150,000 with a ground rent of £50, now having a ground rent of £32,000. A hidden clause in the lease said the ground rent would increase to “1% of the sale price, or 60% of the rentable value, whichever is higher.”
So what does it mean for valuers? Lenders are now asking whether the value will be affected where properties are subject to escalating ground rents. Lenders are understandably very cautious and some are starting to amend their guidance.
So what is the impact on value? Recent examples seen include a modern resale flat built in 2006 with a £300pa ground rent doubling every 10 years together with a high service charge. There was no owner occupier market as they just couldn’t afford it but the investor market was still holding up. However, the assessment had to take into account that at the next escalation in 10 years time, the demand would be questionable and an accurate assessment of the impact on value nearly impossible. Answer – not suitable for lending.
Another was a modest ground rent with a 30 year escalation pattern – the ground rent increase was below the rate of inflation and there was no escalation due within the term of the mortgage. Answer – suitable for lending as it was not deemed to impact the security for that lender. What happens in 30 years time? Your guess is as good as any ones!
So what does it mean for the future? There is limited guidance at present and valuers will once again be metaphorically putting their heads above the parapet… so caution is recommended! Escalating ground rents on houses have had a lot of recent press with the issue due to be discussed in Parliament imminently. It is reported that some senior government officials feel this type of ground rent escalation is unlawful, unethical and serves no purpose other than to put the owner at a disadvantage. The word on the street is legislation is likely.
But what does this mean for valuers in the interim? The CML handbook states that a lender is to be informed of any increase in the ground rent that may materially affect the value of the property. It has been intimated that where the conveyancing solicitor fails to warn the purchaser, and/or the lender providing a mortgage secured on the property, that those lease terms may adversely affect the value of the leasehold property, they may be negligent. Some prominent industry representatives have however expressed their sympathy for conveyancers and solicitors, noting that without an expertise in valuation, they are often themselves unaware of the full implications, perhaps paving the way for counter claims against the “valuation experts”. There’s a surprise I hear you shout!
So what can you do to mitigate your risk? Establish a process for your assessment based on some simple principles:
- Change your standard leasehold caveats to include the assumption of a fixed ground rent – this will at least ensure that legal advisers are alerted to further investigate
- Assess the demand for owner occupation and investors including sales comparables in the locality
- so that you can accurately report in line with individual lender guidelines
- Assess whether the escalation will be in excess of the level of inflation
- Establish the term of the loan and determine if the escalation will occur within the term
As with all cases, if you are unable to make an accurate assessment and cannot provide a clear rationale to support your valuation... err on the side of caution, take a deep breath and do not provide a valuation! Then await the PVQ. Don’t worry, its nearly summer and there’s another new risk lurking round the corner, soon this will be yesterdays news!
KIRSTY SAUNDERS & MATTHEW YUSSUF TALKCPD LTD
For more information on TalkCPD, go to their website: www.talkcpd.com