Reforms to leasehold home ownership announced: commonhold

On 7 January 2021 the government announced its intention to legislate for a series of leasehold reforms in respect of leasehold enfranchisement. As part of that press release the government also confirmed that it would establish a Commonhold Council to “prepare homeowners and the market for the widespread take-up of commonhold.”

The announcement is a response to a series of recommendations set out by the Law Commission in three reports published last summer following a widespread consultation into leasehold reform (“Reinvigorating commonhold: the alternative to leasehold ownership”) initiated in 2018.

A new form of commonhold tenure was introduced by the Commonhold and Leasehold Reform Act 2002 but the model did not receive widespread take-up for a number of reasons. This new announcement by the government is a further attempt to sell commonhold to the market as a viable alternative to leasehold ownership.

Commonhold is a statutory form of freehold ownership, similar to condominium or strata types of ownership in other jurisdictions, which is intended to enable homeowners to exert a greater degree of control over their homes (since flats are jointly owned and managed by the residents) and avoid the perceived shortcomings of leasehold ownership (i.e. devaluing of the long leases over time and variation in quality of property management).

What might be seen as a quirk of property law (that freehold positive covenants do not bind buyers of the original interest whereas leasehold positive covenants do) created the need for leasehold ownership of blocks of flats where positive obligations are required for maintenance payments and other neighbourly agreements. This then meant that a term of years was needed and a rent could be charged (the grant of long leases of interdependent properties). That led ultimately to the abuses in some cases of that form of ownership, for example treatment of tenants as a source of income rather than homeowners, alongside the other inherent limitations of leasehold ownership.

Commonhold allows positive covenants to bind buyers of the original interest and also puts the ownership of the freehold block as a whole with the tenants and means no rent is charged. So, it does away with the areas which had brought leasehold ownership into some disrepute, even if those abuses were by no means pursued by all.

In a commonhold, each person owns the “freehold estate in commonhold” of their particular commonhold unit, for example a residential apartment, together with an interest in the commonhold association that owns the freehold estate in commonhold of any common parts.  The common parts and each commonhold unit will be registered at the Land Registry under separate title numbers.

The rights and obligations of all unit owners and the commonhold association are set out in a “commonhold community statement”.  This is prescribed by legislation but can include “local rules” specific to the relevant building.

Commonhold therefore allows the residents of a building to:

• own the freehold of their individual flat on a commonhold basis;
• jointly own the commonhold association which owns the common parts; and
• control the appointment of an agent to manage the building.

Professor Nick Hopkins, Commissioner for Property Law at the Law Commission has commented that “the creation of the Commonhold Council should help to reinvigorate commonhold, ensuring homeowners will be able to call their homes their own.”

The Leasehold Group has called for the “composition of the Council…to be representative and must include a wide range of experienced, expert voices” and the expectation is that the Council will be formed from representatives within the property industry, leasehold reform groups and the government.

It appears that third party investors and management companies for whom building management generates income streams will be excluded and instead the Council will actively involve consumers - a move which has been welcomed by organisations such as the Leasehold Knowledge Partnership. The assumption must be that this is part of a strategy to promote awareness among consumers which has been cited as a contributing factor towards the previously failed launch of commonhold.

In relation to existing homes, owned on a leasehold basis, the Law Commission recommends that leaseholders should be able to buy the freehold and convert to commonhold and for the process to be relatively affordable for leaseholders.

For new homes, it seems that the government has made clear that the direction of travel is towards commonhold. However, its recent announcement does not indicate that any legislation will be forthcoming in this parliamentary session – it merely refers to the establishment of the Commonhold Council.

It is not yet clear whether the government will mandate the use of commonhold in the future If commonhold is mandated the existing and reformed rights of lease extension, right to buy the freehold and right to manage will be redundant. However, the announced changes to leasehold extension and enfranchisement law suggests that leasehold is expected to continue for some time in a form that will make enfranchisement and lease extension cheaper and more accessible. Retaining leasehold as an option would also give consumers choice as to their form of tenure.

The Law Commission has unequivocally endorsed the use of commonhold stating that “we would go as far as to say that it should be used in preference to leasehold, because it overcomes the inherent limitations of leasehold ownership” such as ground rents and the requirement for lease extension. However, it acknowledges that the benefits associated with commonhold ownership can only be realised if workable in practice.

Incentives

If commonhold is optional, rather than compulsory, the government willneed to take steps to incentivise its uptake, as the Law Commission reports suggests. David Greene, president of the Law Society, has commented that if commonhold is to develop as an alternative to leasehold, then the government “must encourage its creation on a much wider basis” and acknowledged that “incentives will need to be offered to developers, lenders and buyers if this is to happen.”

Developers, landlords and investors are not financially incentivised to implement commonhold since there is a well-established leasehold process - the law and economics of which is widely understood. Leasehold structures provide well defined income streams both arising from the leasehold arrangement (ground rents, recoverable costs, initial premiums, second "extension" premiums) and the ability to sell the freehold interest.

The government’s recent announcement indicates that the opposite approach may be employed i.e. to disincentivise the use of leasehold through removal of the financial advantages by introducing zero ground rents and lower premiums.

The Law Commission has published an open letter to lenders on taking commonhold as security, the letter highlights the perpetual nature of commonhold (it cannot be forfeited in the way that a leasehold interest might be) as evidencing the suitability of commonhold as a candidate against which borrowing can confidently be made.

Cultural change

Transition to commonhold is likely to be complex. In order to secure buy-in from lenders and professionals, work will need to be done to inspire confidence in commonhold as a practical, workable and economically viable alternative to leasehold. This will include the following.

• Care will need to be taken to ensure that a ‘two-tier’ system does not arise between leasehold and commonhold ownership causing lenders / valuers to favour one or the other;
• Improvements will need to be made to the processes by which commonhold is created and registered and ensuring the Land Registry has the capacity to deal with such matters with an eye on the progression towards digitalisation of systems.
• The process by which existing leasehold estates are converted to commonhold will need to be better co-ordinated and streamlined, for example under current law the consent of all persons with a significant interest in the property must be obtained.
• Steps must be taken to ensure that homeowners are willing and able to accept the responsibility of managing their own homes with others living within the same building and without the ability to defer to a landlord.

There are a number of perceived pros to commonhold ownership, including that:

• leaseholders would no longer have the financial burden of onerous ground rents and the costs of purchasing extensions to lease terms;
• control over management of the property and more active engagement than ‘absentee landlords’ in relation to matters such as service charge payment mechanisms and maintenance obligations removing the opacity that some tenants feel arises from a landlord’ managed budget and spend;
• the interest held by the homeowner will not be a ‘wasting asset’ in the way that a lease with ever decreasing term is since the freehold title will endure in perpetuity; and
• the removal of the polarised relationship between landlord and tenant in favour of aligning homeowners’ interests in their building and their homes.

There are also arguments against commonhold, with a number of these being blamed for the dismal adoption of commonhold on previous occasion (fewer than 20 commonhold structures have been established to date):

• commonhold will not solve the problems of close-proximity living and shared buildings, for example homeowners will still face issues where other owners within multi-occupier buildings refuse to contribute towards costs;
• the cost of older buildings or those of particular construction type or classification will remain expensive to maintain and homeowners may not benefit from access to particular contractors and contracts which might have resulted in better workmanship and preferential rates;
• commonhold owners may not take an active interest in the management of their block and there is also a risk of poor decisions made by inexperienced parties (however, the Law Commission has stated that it is “unconvinced that professional freeholders provide a significantly higher level of service than that which could be provided by leaseholders themselves” and does not suggest that commonhold owners will personally take charge but expects that professional managers will be appointed);
• the current law on commonhold is inflexible and not suited for the mix of interests and uses which are commonly seen in large and complex mixed-use developments. However, the Law Commission recognises this and has proposed potential changes which could be introduced to seek to mitigate this. In its report, the Law Commission sets out the need for a solution “which, by itself, can: limit certain common parts to specific unit owners; specify services which only some units are entitled to use; vary the contributions of different units towards different costs; and differentiate voting rights.

For example, developers will be able to establish different “sections” within a commonhold in order to divide the management of residential and commercial interests. The recommendation is that sections will allow for commonholds to be created where “only the unit owners within a particular section are able to vote on matters affecting that section, and only those who benefit from a particular service or facility will be responsible for paying for it.”

In terms of construction, it is proposed that phased development could be used for new commonhold developments. This would enable developers to sell off completed phases whilst retaining control over other areas of the development site. To facilitate such mechanism, it is proposed that developers will reserve rights in the Commonhold Community Statement (which sets out the rights and obligations of unit owners and the commonhold Association and the physical boundaries of the units and common parts).