How UK builders use ‘legal loophole’ to sell on flat freeholds

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Houses in Finsbury Park, North London, England
Houses in Finsbury Park,
North London, England

Shutterstock

  • Housebuilders have used a loophole in a 1987 law to
    avoid offering freehold rights to homeowners.
  • The “perfectly legal” provision allows builders to sell
    the freehold rights to an “associated company” and later on to
    investors to extract rents from residents.
  • Ground rents in some cases have increased sharply over
    time, generating millions in revenues.

LONDON — A few words in a law designed to protect homeowners
appear to have been used by major housebuilders to sell off
freehold rights to investors, leaving the ultimate ownership of
flats in the hands of hidden investors.

The Landlord and Tenant Act 1987 was introduced to protect
homeowners from soaring service charges and unfair leasehold
practices.

It is so poorly written, however, that builders appear to use
basic loopholes to skip legally around provisions which would
give tenants the chance to buy the freehold on their own homes
outright.

So what’s the problem with the law?

The leasehold scandal

Historically, most homes in England and Wales were sold as
freeholds, whereby a buyer would take ownership of the home
itself and the land it sits on.

That changed when builders and landlords identified a new revenue
stream. They started to sell houses and flats under a leasehold
agreement, then sell the freehold onto another investor.

Freeholds are valuable assets, because the owner typically levies
an annual fee, called a ground rent, on the homeowner. Freeholds
offer high annual yields — up to 10% in some instances.

Ground rents can also cost the leasehold owner large amounts of
money. Sebastian O’Kelly, director of the charity Leasehold
Knowledge, says up to 100,000 homes in the UK are “unsellable”
because their owners will be forced to pay spiralling ground
rents — in many instances, ground rents are set to double every
ten years.

The Right of First Refusal

The Landlord and Tenant Act 1987 gave leaseholders of flats the
“right of first refusal” (RFR), which meant they were legally
entitled to buy their freehold before the landlord sold it on to
an investor.

There are several major flaws in the law, however. Firstly, it
contains only provisions for leasehold owners of flats — not
houses — because the vast majority of houses were sold under
freehold at the time.

But it is now common practice for builders to sell new-build
houses under leasehold: There are around 1.2 million leasehold
houses in the UK.

“In my experience developers and non-developer landlords who were
correctly advised were certainly circumventing the obligation to
offer freeholds to leaseholders in this way.”

The second loophole relates to a clause in the law which makes
exemptions for “associated companies.”

It works like this: Builders can register the freehold interests
on a block of flats to an “associated company.” After a period of
two years, the builder can sell the shares — and therefore the
freehold interests — in that associated company to an investor.
Under this arrangement, they are not obliged to offer tenants the
Right of First Refusal.

Persimmon

Companies House records show that on 14 July 2009, Persimmon
Group (No 3) was registered as an associated company of
Persimmon, a builder listed on the FTSE 100 index.

On November 19 2014, records show Persimmon Group (No 3) was
re-named Adriatic Land 2. Its ownership — a single share — was
transferred from Persimmon Homes Ltd to Adriatic Land 2 Ltd.

Adriatic Land is a ground rent fund, the ultimate ownership of
which is unclear because its ownership is hidden behind the
nominee directors private wealth management firm Sanne Group.

Adriatic is
reportedly
owned by one of the funds in the Long Harbour
group, which is controlled by William Astor, the billionaire
half-brother-in-law of former Prime Minister David Cameron.

Mutiple
homeowners have reported
having the ownership of freeholds on
their homes transferred to the network of Adriatic Land companies
without their prior knowledge.

Business Insider asked Persimmon if the associated company was
registered for the purpose of selling freeholds without first
offering tenants the Right of First Refusal, but it did not
respond to a request for comment by the time of publication.

Bellway

Companies House records also show that three companies — Seaton
Group SPV 5, Bellway XI, and Bellway XII — were registered as
associated companies of Bellway, a FTSE 250-listed builder,
between April 2009 and April 2013.

They were subsequently re-named Adriatic Land Group 6 (GR1),
Adriatic Land 3 (GR1), and Adriatic Land Group 4 (GR1) and their
ownership was subsequently transferred to Adriatic Land.

Business Insider also asked Bellway if the associated company was
registered for the purpose of selling freeholds without first
offering tenants the Right of First Refusal, but it had not
responded to a request for comment at the time of publication.

How widespread is the practice?

Emily Fitzpatrick is head of leasehold enfranchisement at Hart
Brown solicitors, and represents leaseholders with claims over
the freehold ownership of their property.

She told Business Insider that landlords had used the “perfectly
legal” practice of setting up associated companies to avoid
offering freeholds to leaseholders.

“In my experience developers and non-developer landlords who were
correctly advised were certainly circumventing the obligation to
offer freeholds to leaseholders in this way,” she said.

“It is a perfectly legal way to avoid having to offer the
freehold of a block of flats which would otherwise qualify under
the 1987 Act to the leaseholders before selling to a third
party.”

Fitzpatrick still comes across instances of the practice, but
says it has fallen out of favour with builders in favour of
another method.

“I come across it from time to time but not as often as I used
to,” she said.

“The most common means I now see is where a developers enters
into a contract with a third party, often a regular ground rent
investor, before any of the flats have been sold. This means when
they come to complete the sale of the freehold to the third
party, the Act does not apply because the developers are obliged
to sell the freehold under a pre-existing contract.

“This is dealt with in section 4(2)(i) of the Act. Such a
disposal is not a ‘relevant disposal’ for the purposes of the
Act.”

Collective enfranchisement

A more recent law — the Leasehold Reform Housing and Urban
Development Act 1993 — means flat owners do have the
right to purchase the freehold from an investor by means of
“collective enfranchisement,” but the process is subject to
complex negotiations.

This can involve costly solicitors, and requires at least 50% of
the tenants of a given building to agree to purchase the
freehold, however. The value of the freehold is determined by
haggling between solicitors representing both the freehold owner
and the leasehold tenants.

Fitzpatrick said: “The loopholes in the Act could be easily
closed by removing some of the situations where certain disposals
are not caught. However, we must remember that leaseholders of
blocks of flats can, in the majority of cases, exercise their
right to collective enfranchisement under the provisions of the
Leasehold Reform Housing and Urban Development Act 1993.”

Fitzpatrick said the Right of First Refusal law does not appear
likely to change: “The recent consultation paper mentions the RFR
but appears to rule out any extension of it to houses on the
basis that it is easily circumvented. There does not appear to be
any proposal to amend the Act itself so I do not think it is
likely that it will be amended. I would be pleased to be proved
wrong.”

Leasehold Knowledge’s Sebastian O’Kelly said a system by which
the market value of the freehold is automatically determined as a
multiple of the ground rent — as is the case in Scotland and
Northern Ireland — would help solve the problem.

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