Guide to ground rents

What are ground rents?

When a new block of flats is built or an existing building converted into self-contained units, two tiers of ownership are created – freehold and long leasehold. The long leaseholds are marketed, while the developer either retains the freehold or offers a share of the freehold to purchasers of the long leasehold interests.

Ground Rent investment companies specialise in purchasing the freehold interests, or ground rents, which are created when the units in the development are sold piecemeal to investors/owner-occupiers.

In the early 20th century, large landowners would 'lease' their estates to house builders for development, and retain an economic interest by imposing annual ground rents on subsequent purchasers. However, there was often little provision for rent reviews, and inflation in the intermittent years has eroded the value of these interests to the extent that they are often uneconomic for small investors to collect.

Why do people sell ground rents?

To remove administrative burden:
There are economies of scale in running large ground rent portfolios which reduce the marginal cost of collecting individual ground rents dramatically. Most ground rent companies will have a custom-designed database system which prints out rent demands automatically on quarter days, reducing overheads and ensuring efficient collection.

To free up capital for future land purchases:
Most vendors are developers who can make large gross margins on land purchases and build-outs, but are not keen to be passive rent collectors. They are often happy to free up the capital to use as equity in land purchases.

To wind up historic developments:
Often the ground rents from a development are the last asset left in the SPV after all the units have been sold. The costs of administering the company's annual accounts/reports are sometimes disproportionate to the income received.

What legal procedures are involved in selling ground rents?

In order to sell ground rents after completion of the development it is necessary to serve pre-emptive Section V notices on the long leaseholders. This gives them the right but not the obligation to purchase the ground rents at the price states on the notice. They have two months to respond, and then a further two months to nominate a purchaser.

Most experienced purchasers will take care of the service of Section V notices at no charge to the vendor, even if the long leaseholders subsequently purchase.

Once the Section V notices have expired the transaction can proceed as normal, with both sides' solicitors agreeing an exchange/completion date. This is normally the same day. CPSE enquiries are rarely required due to the small lot sizes involved, which reduces both sides' legal costs.

What might my ground rents be worth?

The value of ground rents is a combination of the passing income and the length until lease reversion, with the greater store of the value resting in the former. The rent review provisions are important as they affect the value of the income stream. Insurance and management has a small added value, but most professional ground rent investors will appoint 3rd party managing agents.

I am planning a new development of a block of flats, can I sell the ground rents before selling the flats to aid cash flow or lock in receipts early in the build cycle?

Yes. Additionally if you agree a sale and exchange before 50% of the flats are sold, completion can occur when the last flat is sold. This avoids the need to serve Section V notices on the long leaseholders, and the two month expiry period this entails.