As soon as you consider buying a property, you'll come across the terms freehold and leasehold.
Nowadays they are very much still relevant for residential and commercial property ownership - according to official government statistics there are over 4.86 million leasehold dwellings in England, roughly 20% of the total housing stock.
If you understand the differences between the two, and the rights and responsibilities that come with leasehold property ownership, then you'll be able to make an informed decision as to whether to buy the property you have your eye on.
What are leasehold and freehold?
When explaining the difference between freehold and leasehold property, freehold is easier concept to describe because it is what we tend to think of as ownership.
A freehold property owner owns both the building and the land on which it stands (although your lender could still repossess it if you donât keep up mortgage payments). Thanks to the Civil Aviation Act 1982, the freeholder also owns the rights to the airspace above their property up to about 150 metres.
Total ownership is also known as title absolute or by the term fee simple.
In contrast, a leasehold property owner has bought a lease - that is a right to occupy and use the 'demised property' for a specific period of time, known as the lease term.
The lease term can be decades or even centuries. Most leasehold properties have long leases of 99, 125, or even 999 years.
The freeholder remains the owner, at least of the land on which the property stands, and possibly of the fabric of the building. When the lease expires, the rights to use the property revert to the freeholder.
Under the terms of any lease dating from before 2022, a leaseholder is obliged to pay ground rent, an annual fee in exchange for the lease to the freeholder.
Ground rents for residential leases vary widely. Those for newer properties might be thousands of pounds every year, while those for older properties might be expressed in old money - pounds, shillings and pence - which when converted into today's value equates to a few new pounds.
Some leaseholders may find that they pay nothing, despite the lease stating a ground rent. Because leases can last hundreds of years, the identity of the freeholder can be difficult to ascertain. The right to collect rent can easily be forgotten or become unclear over generations. In such cases, your conveyancer will usually recommend that you take out an indemnity policy - insurance in case anyone does claim it at a later date.
The Leasehold Reform (Ground Rent) Act, which came into effect in 2022 prevents ground rent from being charged on new and extended leases.
Leaseholders may be required to pay a service charge. Typically, service charges apply for properties that are part of a more recently built housing development, where additional, communal services are provided, such as a gym or a garden, or where there are shared spaces such as stairways, corridors and pathways. Service charges might be used by a managing agent or management company to pay for the indirect costs involved in carrying out their work, as well as the direct costs such as electricity for the development and labour costs for staff.
Service charges might also cover small expenses for maintenance. But for larger ones - major repairs and improvements - leaseholders may be required to pay into a sinking fund.
We have another article that covers all the fees and charges a leaseholder pays.
Special lease terms apply to some types of property. For example, retirement properties in sheltered housing schemes tend to set a minimum occupier age.
Share of freehold flats
Some leasehold flat owners may have a share of freehold or commonhold.
This is where the flat owners collectively own the freehold of the building and the land on which the property sits as well as each owning a leasehold interest in their individual flats.
Share of freehold offers many of the benefits of freehold ownership, such as increased control over property management decisions and no ground rent payments.
However, share of freehold properties still require leaseholders to work together in managing the building, which can lead to potential disagreements and disputes.
Share of freehold is usually structured through a company. The company owns the freehold and each leaseholder owns the same proportion of shares in the company as any other. Day to day decisions are made by the appointed directors, whereas larger decisions are voted on by all shareholders.
As with any form of community ownership arrangement, conflicts can arise or parties can be disinterested in managing the entire property as well as their own part. It is important that the company that owns the freehold is structured in such a way so as to provide a way of resolving disputes as well as allowing a few, or even a single, person the control that they might need to manage the freehold alone if no-one else wants to do so. The is an additional layer of complication given that leaseholders may sell their homes and with them, their share of the company, and thus company ownership and management dynamics will change.
If you're thinking of buying a commonhold property, you should not only look at the lease but also the articles of association of the freehold-owning company as well as any shareholders agreement. A lack of a shareholders agreement, or use of the model articles should be a warning sign that the other leaseholders are not aware of key risks.
Northern Ireland and its differences from the rest of the UK
The leasehold sector in Northern Ireland differs significantly from England, Scotland, and Wales.
In Northern Ireland, most houses are sold as freehold, and long leaseholds are generally more common. The differences in legislation mean that some leasehold reforms may not apply to Northern Ireland, so potential homebuyers should carefully research local laws to understand their rights and obligations.
Consulting a conveyancing solicitor familiar with the nuances of the Northern Irish property market can be an invaluable resource in navigating these complexities.
Buying leasehold property
When you see a property that ticks the boxes, or simply that you fall in love with, whether it is leasehold or freehold probably won't be the deal breaker in terms of whether you buy.
But bear in mind the following when considering leasehold versus freehold.
Short leases and the impact on value
A short lease is one where the remaining lease term is 'short' - typically less than 83 years.
A short lease can have a significant implications on the property's value and mortgage eligibility.
The reason why short leases affect the value of the property so greatly is that when the remaining lease term is less than 80 years, the freeholder becomes entitled to 50% of the marriage value of the lease if it is extended. Marriage value is the difference between the current valuation and the valuation after the lease is extended. Since the before and after valuations can be large, so can the marriage value.
83 is a number of importance because a leaseholder must have lived in the property for at least 2 years before they have a right to extend the lease. That means that if there is less than 83 years left on the lease when the property is sold, the new owners will have to act promptly after 2 years to avoid having to pay the freeholder half of the marriage value.
Further, because a leasehold owner may not be able to afford to extend the lease once there is less than 80 years left, mortgage providers may be hesitant to lend. This in turn increases the post-extension value and therefore the marriage value.
High (and increasing) ground rents
At sometime in the early 2000s, large housebuilders realised that they could improve the share prices of their companies by selling new build properties as leasehold, keeping the residual value in the freehold and charging ever increasing ground rents to generate income.
Traditionally, ground rents were set for the length of the lease and, as a result, eroded by inflation.
Instead, the housebuilders introduced ground rents that increased every few years. As a result, what seemed affordable and reasonable when the property was built can now be a significant cost.
Because ownership of the property reverts to the freeholder if ground rent isn't paid, high ground rents can make it difficult to obtain a mortgage (or remortgage). Selling can be difficult.
One solution is to extend the lease, which has a consequence of reducing the ground rent to at peppercorn at the most. However, legal fees for lease extensions can be costly.
High service fees
Like high ground rents, high service fees can be an issue.
Paying them is another contractual term of the lease, and there is often no cap on how much they can be. In theory, it should be clear how a leaseholder benefits from the charges they pay, but not all management agents are as transparent as they should be. In particular, be aware of sweeper clauses in your lease and ask how often they have been used.
Another possible cause of high fees is mismanagement - for example, not maintaining water pipes so that wear and tear causes leaks that then cause further, more extensive water damage to flats and communal areas.
Although leaseholders have a right to ask for information about how charges are calculated, a right to be consulted on long-term high costs and for evidence as to how it is spent, there are many ways in which charges can be overinflated.
The Leasehold Reform Act 1967 (LRA) is a piece of legislation that has significantly altered the landscape of leasehold ownership in the UK.
Notably, it gives leaseholders two important rights in respect of extension of a lease and enfranchisement.
The government has signalled that it may give leaseholders further rights in 2023.
Lease extensions and their costs
You can extend a lease, increasing the remaining term. This can be a wise move for leaseholders, maintaining or even increasing the value of your leasehold home. However, lease extension can be a complex and costly process.
Currently under the LRA, a leaseholder has a right to extend a lease by 90 years for flats or 50 years for houses. It is being considered whether to give all eligible leaseholders the right to extend by 990 years, regardless of the type of property.
The process for extension usually starts with the leaseholder approaching the freeholder to negotiate.
If an informal agreement for extending the lease cannot be reached (and beware of the traps), there is a legal procedure that when followed guarantees that the lease is extended, unless the freeholder can show that they have a valid reason (as set out in the LRA) why they shouldn't.
In return for the extension, the freeholder is paid. The cost of a lease extension depends on various factors, including the property value, the remaining lease term, and the annual ground rent.
You are likely to require the assistance of a conveyancer to follow the correct legal procedure and register your ownership at the Land Registry, and a specialist surveyor to value the new lease.
You may also be asked to pay some of the legal costs of the freeholder.
Enfranchisement: leaseholders working together to buy the freehold
Enfranchisement offers leaseholders the opportunity to purchase the freehold of their building, granting them more control over property management and eliminating ground rent payments.
Additionally, leaseholders may collectively enfranchise (purchase the freehold of the whole property).
To be eligible for enfranchisement, at least half of the leaseholders in a building must participate, and the property must meet specific criteria, such as having a minimum number of flats and not being part of a larger building.
Enfranchisement costs vary depending on the property's value, location, and other factors, but it may ultimately prove to be a worthwhile investment for leaseholders seeking increased control and long-term financial benefits.
When considering enfranchisement, it's important to weigh the costs and potential benefits. While buying the freehold can be attractive in the long run, the initial outlay can be significant.
If you go ahead, generally, it is better to do so through a First Tier Trubunal process (or a Leasehold Valuation Tribunal if the property is in Wales). The Tribunal will determine a fair purchase price and other terms.
Collaborating with other leaseholders, seeking professional advice from a conveyancing solicitor, and carefully evaluating your financial circumstances can help ensure a successful enfranchisement process.
Note that an alternative to enfranchisement is to exercise your Right To Manage (if you qualify).
Freehold vs leasehold: which should you buy?
As a result of the 'leasehold scandal' in 2017 and the subsequent findings by the Competitions and Market Authority in 2020 that the largest housebuilders were taking unfair advantage of leasehold buyers, many people have become wary of buying a leasehold property.
But you shouldn't rule out living in a leasehold home, particularly if the lease dates from a much earlier time.
Why would you buy a leasehold property?
The pros of buying a leasehold property are:
Value and accessibility
Leasehold property prices are often lower priced for the same living space or facilities as a freehold equivalent. The lower cost of the property means that associated costs, such as Stamp Duty Land Tax, Land Registry fees and the deposit required are also lower.
This often makes them more accessible to first-time buyers.
Because rental income tends not to be determined by whether the property is freehold or leasehold, the yield, that is rent as a proportion of the cost, tends to be higher for leasehold vs freehold, making it more attractive for buy-to-let investors looking for a good return on their investment.
No responsibility for repairs and maintenance
The freeholder or the managing agent will deal with the upkeep and repairs to the fabric of the building such as exterior walls, and communal areas such as entrances, as well as arranging and paying buildings insurance. New build houses and flats, many of which are sold as leasehold, are unlikely to require expensive renovation works for some time.
Covenants controlling behaviour
Covenants are obligations in the lease to do, or not to do, certain things. As examples, they may define where vehicles may be driven or parked, forbid loud noise being made during night time hours, and prevent leaseholders from making structural amendments to their property. Breaking the covenants amounts to breaking the terms of the lease and depending on how serious the breach is, a freeholder (on behalf of the other leaseholders) may apply to court to have the lease forfeited or for damages.
You can read more about positive and restrictive covenants.
The cons include:
Permission may be needed to carry out improvements or changes
You lease may require you to seek approval of the freeholder if you want to extend or improve your property, and it might not be given.
Requirement to pay service charges
The service charge may be expensive or pay for things that you aren't important to you, such as maintenance of an ornamental garden. Maintenance costs may be high for parts of the property you don't use, such as lifts.
Restrictions on what you can do in your home
Your lease may not allow you to keep pets (or certain types of pets such as cats and dogs). You may not be able to run a business from your home either (although you should be able to work at home). You may not be able to sublet, or let a room on a short term basis.
Little control over the timing of large expenditure
You might be called on to make payments into the sinking fund for amounts that are difficult to afford at that time and that maybe don't affect your home.
One of the responsibilities of your conveyancer is to pick up potential issues before you buy. You should be able to check for those things that you see as disadvantages before you buy, provided that you are being advised correctly. Of course, with more potential risks, there is more for your conveyancer to check during searches, so expect conveyancing fees to be moderately higher for a leasehold tenure.
Poor advice from conveyancers recommended by the housebuilders, and therefore had a conflict of interest to disclose risks, is what is at the heart of the leasehold scandal, rather than the type of property.
For further information, read about buying a leasehold flat.