In from the cold for commonhold? The UK government renews efforts to promote leasehold alternative

Briefing

It's no secret that the introduction of commonhold just over 16years ago proved to be a very damp squib. I remember buying one of a number of books written on the subject, attending various training sessions as well as delivering a talk to colleagues on the brave new world that was commonhold. I kept my notes for a few years, just in case, but it's safe to say I no longer have them.

For a whole host of reasons, the concept just did not take off, but the UK government is trying once again to promote commonhold as a viable alternative to leasehold. For this mission to have any chance of success, it must drill down into why those operating in the market did not open their arms to commonhold previously, find new ways of convincing developers to embrace it as well as facilitating the process of conversion of existing leasehold structures to commonhold.

The Law Commission's report Reinvigorating commonhold: the alternative to leasehold ownership is one of three interrelated reports published recently by the Law Commission as part of a package of comprehensive reforms to property ownership in the UK.

Might commonhold have something in its favour this time round? Over the last few years, a light has been shone on certain abusive practices within the existing leasehold system, most notably some housebuilders introducing escalating ground rents (sometimes doubling every 10 years) that have impacted on the value and marketability of affected homes. This backdrop is certainly helpful in the quest to revive interest in commonhold, and could make the government's task of convincing buyers that commonhold should be seen as the method of ownership of choice a little easier.

Commonhold made simple

Commonhold is essentially a type of freehold ownership, similar to strata or condominium types of ownership that are seen in other jurisdictions such as Australia, Canada and the US. It addresses two of the issues currently faced by tenants of residential leasehold buildings: the enforcements of covenants between tenants, and the diminishing value of leasehold property as an asset over time.

With commonhold, each unit owner has the "freehold estate in commonhold" of their particular unit. The common parts of the block or development are owned by a Commonhold Association (of which each unit owner is a member) and are separately registered at the Land Registry. The rights and obligations of all the unit owners are set out in a Commonhold Community Statement. There is therefore no third party landlord in the equation.

The pros and cons of commonhold

There are some obvious advantages of a commonhold system:

Unit holders have complete control over the management of the block and the setting of rules and regulations, service charges and maintenance arrangements.
Onerous ground rents are removed, as is the cost of extending a lease meaning that the interest is no longer a wasting asset as is the case with a leasehold.
The unit holders do not have their risk of their interest being forfeited as it the case, at least technically, under a lease.

There are also some potential down sides:

As those tenants who have already collectively bought the freehold of their buildings will know, commonhold will not solve the day to day problems of shared buildings; competing interests between different individuals over spending priorities will not go away and nor will difficult personalities.
In practice, the ongoing management arrangements for a block can be a headache, particularly where unit holders are inexperienced or the make-up of the block is such that many of the unit owners are frequently absent or the units are held as buy to let investments. The advantages of a professional and distanced freeholder can sometimes be a plus where there is apathy within a block ,or persistent conflict.
The commonhold model is a simple one. How it will fit in the context of mixed use schemes, which are becoming increasingly popular with developers, is not clear. The driving force behind the concept of commonhold is the ideology of homeowners wanting to join together to manage their building. Commercial operators may not share this vision. The new proposals do introduce some changes with mixed use premises in mind. These include the introduction of "sections" designed to limit decision making to different parts of the commonhold. These ideas will need to be finessed.

Conversion: stick or carrot?

Currently the Law Commission reports suggest that commonhold should remain optional rather than compulsory and so do not propose removing market choice. Financial incentives will need to be offered to developers and buyers for commonhold to have a chance of taking off; lenders will need to get on board and be convinced that the structural model of commonhold can offer them sufficient protection. Thought will also need to be given to maintaining a level playing field between leasehold and commonhold ownership so that there are no valuation or lending issues as against one or the other.

The process of converting existing leasehold developments to commonhold will need to be carefully considered and streamlined. Currently the consent of all parties with a significant interest in the development must be obtained for there to be conversion which is clearly a significant hurdle. The proposal is that this should be reduced to 50% of the leaseholders, with the removal of the need for lender consent. Freeholder consent will still be needed which effectively means that there will need to be a collective enfranchisement to clear the way for conversion.

Most controversially under the proposals, any dissenting leaseholders could be forced to convert to commonhold and to share the conversion costs by way of a compulsory equity loan from the government, to be charged against their respective units and repaid on sale – this clearly has political implications and is likely to raise eyebrows. The only alternative to this seems to be a sort of hybrid system of part commonhold and part leasehold within a single block which would be messy to say the least, particularly in relation to dispute resolution.

Is there market appetite for commonhold?

Currently there are several factors that make the current leasehold system more appealing to developers and their funders. Much of this is down to familiarity and flexibility and for lenders a clear income stream deriving from the leasehold set up – ground rents, lease premiums, future lease extension premiums and the value of the freehold reversion. Commonhold will undoubtedly be a neat system for small simple residential blocks but will it be suited to the complexities of many modern day mixed developments that combine commercial use with private and affordable housing? Ultimately, if the financials are right, developers will be swayed, but as long as there is more money to be made from leasehold structures, commonhold's comeback is unlikely to be left on ice.