Leasehold property explained

It’s a constant source of astonishment to those unfamiliar with the vagaries of British property law that millions of people quietly accept living with a house buying system which is – quite literally – feudal.

The distinction between freehold and leasehold property existed at least as far back as the Domesday Book of 1089. Land equalled wealth and power in the Middle Ages, and wealthy and powerful families wanted to be able to retain and monetise it. And so the concept of leasing swathes of land to peasant farmers for a set period of time, in return for a share of their crop or their labour, was born.

Today’s system has been refined, but the choice of leasehold vs freehold may still seem like a no-brainer. Who wouldn’t prefer the independence and security of a freehold?

Unfortunately, there are many places in which freehold apartments are a rarity. There are whole swathes of prime central London owned by Britain’s ancient, landed estates (like the Grosvenor Estate, which owns much of Mayfair and Belgravia), where leasehold is the only option going.

Before deciding which is better, leasehold or freehold, it’s therefore important to understand the system which has governed British property transactions for centuries, and which is currently facing a period of reform.

How does leasehold work?

The meaning of freehold property (usually a house) is that it’s bought and sold free and clear. The buyer owns both the property itself and the land upon which it stands, with no time limit or charges attached.

A leasehold property (usually a flat) is one which is bought only for a set period of time. During that time, an annual ‘ground rent’ must typically be paid to the leaseholder, sometimes just a few pounds, but often increasing over time to many thousands.

When the lease runs out, the property is forfeited back to the landlord – although in reality this rarely happens, because leases can be extended.

What is a ‘share of freehold’ property?

In some cases the owners of all the flats in a building co-own equal shares in the freehold. Typically, share of freehold homes are period conversions with only a small number of units, and sometimes the owners set up a company as an ownership vehicle for the freehold.

The owners are able to decide collectively how to manage issues like building maintenance. This can sometimes become fractious, but is usually considered preferable to being stuck under the control of a landlord.

The crucial benefit is that you can also extend your lease without paying a premium.

Because of this, share of freehold homes tend to be worth more than leasehold ones. The best share of freehold buildings are when owners collectively appoint a managing agent to help run and manage the building, collect service charges and have an adequate sinking fund in place to ensure the building is properly maintained overtime.

Extending a lease

How do I extend a lease?

Your first step when extending a lease should be to approach your freeholder to ask if they would be willing to negotiate an extension. They don’t have to say yes, but if they do you could save time and money. Saying that, you should always use a solicitor or surveyor to help you negotiate.

Once you have been the legal owner of a property for two years or more, you legally have the right to extend your lease, so in practice its rare for a freeholder not to agree to it.

What happens if you can’t agree on a price to extend a lease?

If your landlord won’t negotiate, or you can’t agree a price, you can go via a more formal route so long as you have been registered as the owner of the property (with the Land Registry) for at least two years.

This involves hiring a qualified valuer to establish how much you should pay, and serving a legal notice on your landlord. If you still cannot agree you might have to go to a legal tribunal, which will make an order on your behalf.

When do I need to start thinking about lease extensions?

The magic number here is 80. Most leases start off at 125 years (although there are exceptions). When it winds down to 80 years it becomes an issue – mortgage lenders might be unwilling to lend on properties with leases of less than 80 years and, crucially, this is the point at which extending a lease starts to cost more and more.

So leaseholders should ideally start to plan to extend their lease well before the 80 year mark.

The process is likely to take six months to a year.

How do you calculate the cost of extending a lease?

Lease extension cost depends on how much the property is worth, how long its lease is, and how much the ground rent is.

Put simply, the more expensive the property and the shorter the lease, the more it costs, which is why acting sooner rather than later is advisable.

Professional fees will add around £4,000 to £5,000 to your total bill, and you may also have to pay your freeholder’s costs.

If the property is a second home or investment property you may also need to pay Stamp Duty on the deal, although costs might be tax deductible – the rules are very complex so good professional advice is essential.

What’s the story with short lease property?

Technically, any property with a lease of less than 80 years has a short lease. But occasionally you will see a property for sale with leases in single figures.

The plus point of these properties is that they should be priced to take into account the cost of extending a lease. A flat which should be worth £2m, but which has a very short lease estimated to cost £1.5m to extend, will be priced at around £500,000.

This scenario has risks. Until you have negotiated, you can’t be sure how much you will end up paying for your lease, and you’re unlikely to be able to raise a mortgage on a property with a very short lease. However, it does also have potential benefits.

There will be less buyer competition for this kind of property, so you may be able to negotiate a healthy price reduction.

Occasionally, buyers who only plan to be in the British capital for a few years will buy a short lease flat as a more secure alternative to renting.

And property developers sometimes target short lease properties, in order to cut their entry costs. Not only are the properties cheaper to buy, but Stamp Duty will be lower too.

Owner occupiers may take the same view, taking advantage of low entry prices to buy a home at a better address than they could otherwise afford on the assumption that future inheritances or pay rises will one day allow them to extend it.

Should you buy a leasehold property?

Owning a leasehold property will undoubtedly come with more complications than a freehold, but it doesn’t have to be a deciding factor. If buying a leasehold property is the best way to secure a suitable house in your chosen area, then just make sure to seek professional advice and pay attention to that 80 year deadline!