It is open to the freeholder and the leaseholder of a property to negotiate an arrangement other than the automatic expiry of a lease at the end of its term. They might agree to extend the lease beyond the original term.
The leaseholder might be allowed to buy the freehold of a leasehold property. This is called the ‘enfranchisement’ of the lease because it is freed from, and replaces the overriding freehold. In both cases, the conditions and the price are to be settled between the freeholder and the leaseholder.
The relevant pieces of legislation are the Leasehold Reform Act 1967, the Landlord and Tenant 1987 and the Leasehold Reform, Housing and Urban Development 1993. These Acts were later amended by the Housing 1996 and the Common hold and Leasehold Reform Act 2002.
Importance of extension and enfranchisement to leaseholders
Some freeholders automatically extend the lease whenever it is assigned e.g. if a 125 year is assigned after 30 years it is extended by a further 125 years. This is valuable for the leaseholder because otherwise the value of the lease will drop towards the end of the term. For the freeholder, the lease may be seen to be more valuable when it is originally sold to the leaseholder.
Most leases would expire on the original date but for legislation, which forces freeholders to grant fresh leases of 90 years longer than the existing term.
The leaseholder may now, under certain circumstances, acquire the freehold whether or not the freeholder agrees. The freeholder would receive compensation. This avoids the situation of the property reverting to the ownership of the freeholder at the end of the lease and the leaseholder having to buy it back.
Where the property stands on a definable area of land, the freehold of the land is passed to the leaseholder and this includes any buildings on the land. There is a problem for flat owners as the property is part of a larger building and so does not have a distinct piece of land to which it is attached.
Collective enfranchisement occurs in this case whereby the flat owners must come together to nominate one person or body to buy the freehold. The flat owners then continue to hold the leases of their individual flats. The leases are not enfranchised in the same way as with individual enfranchisement because the freehold has simply changed ownership.
The flat owners may collectively own the freehold to the whole building but the flat owner cannot just acquire the freehold of the individual flat. Those who cannot afford to join in are given the right to extend their existing lease by 90 years which solves the problem of the lease being a wasting asset and less attractive to buyers.
If a substantial part of the building is let for non-residential purposes then there is no right to buy the freehold, though the flat owners still have the right to be granted an extended lease.
Qualifying conditions for buying the freehold
Both the tenants and the block of flats itself must qualify under the Leasehold Reform, Housing and Urban Development Act 1993 and a minimum number of the qualifying tenants must join in with the purchase of the freehold. Two thirds of the flats must be let on long leases and the leaseholders involved must own half the flats. At least half of the participating, qualifying tenants must satisfy the residence test under this Act (now amended, see below).
A tenant qualifies if he/she is a ‘tenant’ of a ‘flat’ under a ‘long lease’ at a ‘low rent’. The exception is if the lease was granted for a ‘particularly long term’ i.e. over 35 years in which case the rent is not an issue. Most flat owners will be classed as tenants even if they are sub-leasing, unless the property is used for business or as a charitable housing trust.
A flat is classed as a flat if at least part of the property is above or below another part of the building so this includes both one storey and two storey flats above shops.
A long lease is an original lease granted for a term longer than 21 years regardless of whether the flat owner was the original tenant or how long of the term is left. The rules for deciding what constitutes ‘low rent’ are complex but most cases the lease will be for a ‘particularly long term’ anyway.
The Common hold and Leasehold Reform Act 2002
This Act abolished the low rent test as criteria for extending leases, making it much less important. It also abolished the residence test, mentioned above, for the extension of leases and for enfranchisement. The new requirement brought in is that leaseholders must have held their lease for at least two years before exercising the right to enfranchise or extend the lease.
How the Leaseholders may buy the freehold
If four or more leaseholders want to own the freehold together they must set up a corporate body to do so, because the Law of Property Act 1925 states that no more than four individuals may share a freehold. This body could be a company or a society but the cost of setting this up and all the legal and professional costs for both sides will fall to the leaseholders.
The actual purchase price of the freehold can be arranged with the freeholder or decided by a leasehold valuation tribunal. The price is based on consideration of the open market value and the marriage value.
The open market value reflects the income the freeholder would have received from rent and the prospect of regaining possession of the parts of the building that are currently let. The marriage value is important because it is assumed that the leases and the freehold have a greater value when enfranchised and combined but this is often a low figure, particularly when the leases have a long term to run.
Serving a notice on the freeholder
Before leaseholders commit themselves, it is recommended that they serve a notice to the freeholder who must then provide information like title deeds, surveyor’s reports and planning restrictions. The leaseholders can then make an informed decision based on this information relevant to collective enfranchisement and a possible sale.
The leaseholders can also request the freeholder to consider a voluntary sale, opting out of all the elaborate procedures. The freeholder may agree to this, fully aware that he/she can be forced to sell eventually.
The procedure in detail
A surveyor carries out a valuation, commissioned by the leaseholders. Then the leaseholders give the freeholder an initial ‘section 13’ notice of two months to respond to a proposed price. They provide details of the leaseholders involved and the nominated purchaser, proof that they qualify (as detailed above) and which parts will be enfranchised, which would be leased back. The freeholder may not now sell to a third party.
If the freeholder requires evidence of the qualification of the participating leaseholders, then the nominated purchaser has 21 days to provide this. If they do not, then the freeholder can treat the initial notice as being withdrawn. Otherwise, the freeholder must serve a counter notice accepting or giving their reasons for rejection. The freeholder also gives details on whether he/she accepts the price, what exactly will be included in the sale and what would be leased back.
The freeholder may refuse to lease back parts of the premises in order to increase the overall price and hopefully deter the leaseholders. Freeholders may also convince a court that they intend to redevelop the whole block of flats if there is less than five years left on the majority of the leases.
A referral to a Leasehold Valuation Tribunal must take place within at least two months and no more than six months after the freeholder’s counter notice. After six months with neither agreement nor referral the initial notice will again be treated as withdrawn.
Once the terms and price have been settled, there are two months to exchange contracts with a further two months after this available for the nominated purchaser to ask the court to transfer the freehold. Again, if this is not complied with the freeholder may ask that the notice be treated as withdrawn. If for any of these reasons, the sale does not go ahead the leaseholders must wait at least a year before serving another initial notice.