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December 9, 2010
Ground Rents – An Increasingly Popular Investment
The Estates Gazette recently published an article by John Churchouse which considered the value of ground rents as investments. We have summarised some of the main points below.
What are Ground Rents?
A ground rent is the ownership of an interest under which a leaseholder pays a regular amount of rent. The rent arises when land or a building is sold on a long lease and the leaseholder covenants with the lessor to pay ground rent (and other obligations) for the remainder of the lease. As the lessee is responsible for maintenance and repairs, the lessor will receive a virtual net yield.
Why are Ground Rents Secure Investments?
The ultimate sanction for a tenant’s failure to pay ground rent is forfeiture of the lease, which results in a disproportionately large payment to the lessor. Lessees rarely default and if they do, the mortgagee steps in to cover the arrears.
How often is Rent Reviewed on Ground Rents?
Modern residential leases contain provisions for reviewing the rent. One of the most common bases for review is for ground rents to double every 25 years. However, modern lease structures sometimes incorporate more regular reviews and can be linked to RPI or other mechanisms. Some reviews are calculated as a percentage of capital values or market rents, which can lead to substantial uplifts.
The Leasehold Reform, Housing and Urban Development Act, 1993
Under the act a tenant can extend its lease for 90 years on the payment of a premium to the freeholder. If the lease has less than 80 years remaining the freeholder will also obtain marriage value.
Marriage value occurs where a lease is reduced in value because it has less than 80 years remaining and as a result the tenant has to pay an additional premium to the landlord to renew the lease. Upon paying the premium, the ground rent will normally diminish to a peppercorn rent.
The freeholder will be compensated for loss of ground rent and reversion, but some freeholders don’t like losing the consistent cashflow and potential growth from ground rents.
Other Benefits from Ground Rents
Some investments generate a significant level of insurance commission, particularly for the owners of large portfolios that benefit from economies of scale. When a freeholder takes out insurance cover for their portfolio, any discount does not have to be passed on to the tenant and they can benefit from any saving. However, this does not necessarily provide long term value.
Depending on the lease, tenants may have to pay a licence fee to make alterations, sell or undertake mortgage enquiries.
Why Invest in Ground Rents now?
Ground rents not only provide a consistent and stable cashflow, with the potential for significant upside from marriage value and other asset management opportunities, they are also less sensitive to traditional market forces than ordinary rents, which in an unstable market provides added security.
Ground rents will normally increase even when property prices and rents are stagnant. This is because:
- The lease is often subject to fixed reviews at specified intervals.
- The longer that a lease is not renewed after the length of lease falls below 80 years, the greater the marriage value of the lease i.e. the greater the payment to the landlord.
The secure returns and the opportunity to capitalise on marriage value in leases has led to an increasing number of investors purchasing ground rents. With the cloud of uncertainty still hanging over the economy and the property market, investing in ground rents offers a stable alternative with some interesting opportunities for significant upside.