Understand the key points you should be asking to see in a lease.
When speaking to your broker about a property, understanding the lease terms should be equal to understanding the yield and price point of the property. Thankfully all Baron & Cabot investment properties have been through the due diligence. Below is what we look for.
The length of the lease is the first thing that we would understand. While there is no defined term for a lease general consensus points at over 125 years with most comfort in the 200 years plus.
While you have a right to extend your lease by 90 years it is not something you want to be thinking about when you buy a new property. Once you run below 70 years mortgages will start to get expensive and some providers would rather not lend.
Extending a lease with 95 years remaining will cost £5,000 plus any legal help you use to make the extension. This will add an additional 90 years to the lease, allowing some rough guidance on how you can down (or up) value a property based on lease length.
Once we have looked at lease length and are happy with this we will look at the cost of the ground rent. Again there are no set figures for ground rent but some basics which you can work to. In general terms we want the new 0.1% ground rent cost if possible. This would mean that a £100,000 property would pay £100 per year, £200,000 property will pay £200 per year etc.
While most developers are slow to do the 0.1% ground rent we are starting to see more and more new projects with this, and we naturally negotiate this in as and when possible.
One benefit of this as a ground rent price is that all mortgage providers prefer this, with Countrywide at the time of writing refusing to mortgage properties without the 0.1% ground rent. Although this would not be a deal breaker in a lease, suggested sub £250 ground rent is ideal with the real crux being how the ground rent is increased.
Ground Rent Increases/ Reviews
While there are few parts of a lease which are complete deal breakers (lease length or price in isolation may just change the value we have on the property) a poor ground rent increase would certainly mean walking away from a project entirely.
In each lease there will either be a static ground rent (it never increases) or an increasing ground rent. In itself an increasing ground rent is not an issue at all so long as it is not increasing faster than inflation.
Although unusual some less scrupulous brokers and developers will have ground rents increasing faster than inflation. This may be doubling after 10 years, or increasing at certain rates which add value into the ownership of the freehold. The worst case is not having any restrictions at how much it can be increased.
While £250 per year doubling every 10 years may not seem a lot in the short term, in the long term this may be significantly above inflation resulting in what feels like an extremely expensive ground rent in the future.
Another inherent cost of a leasehold property is a service charge. A service charge should if calculated correctly keep the value of the property high and common area’s looking how the tenant would expect them.
A landlord will always have a cost of repair and upkeep on a property whether its freehold or leasehold, with the benefit of a service charge being that an investor can be fully ‘hands off’ with their investment rather than arranging house painting or gutter checks etc.
While a service charge should be seen as a benefit to some investors knowing roughly how much it should be is another question.
As a very rough rule of thumb, for properties outside of London we would expect a service charge to be around £2 per square foot per year. So if you have a 450 square foot 1 bed in Liverpool we would expect to be around £900 per year.
This rule is a benchmark however and knowing the quality of a property, what sort of amenities there are will also change that number. For example a small brick building with no lifts may be significantly cheaper, while a large development with common area’s, high floors for window cleaning, gymnasiums, swimming pools and concierge are likely to cost more.
With the service charge it is important to work with your advisor to forecast what rental increases should be expected from a development with these amenities and whether an increase (or decrease) in service charge is justified in the rent.
A lease with a few exceptions can rarely be seen as good or bad based on individual points but is checked to ensure a few key points stand up, and the remaining ones make sense in the over all picture of the type of property, type of rent and purchase price of each individual unit.
The lease review is an early part of Baron & Cabot’s due diligence and we would always advise any investor to make it a point to check this when comparing what appear to be like for like properties. Whether completed or off plan the lease of a property can be substantial in the amount of profit you will see both short and long term.