One of the more niche areas of property investment which relatively few people are aware of is portfolios of freeholds.
The freehold legal interests in question are generally created where a house has been converted into flats.
Houses are generally freehold but when converted into flats, those flats are then sold off on long leaseholds. The value in the property is almost all then crystallised at that point, as the selling freeholder retains only an abstract legal interest which will never result, in practical terms, in him or her regaining possession of the property.
A freehold interest in this scenario, in capital terms, might be worth as little as a few thousand pounds.
Are reversionary freeholds worth anything or just a hassle?
By creating flats and selling them off as leases, a house owner, if he/she remain as freeholder, may be left with the hassle of complying with freeholder obligations to maintain structure and exterior, arrange buildings insurance, collect money from the leaseholders and so on, for no obvious return.
Consequently, with converted houses, many freeholders, having extracted almost all value from then property on selling the fats, have little or no interest in such role and are quite happy to sell the freehold to either the leaseholders or a 3rd party.
Making money by buying portfolios of freeholds
A professional property investor/manager i.e not the long leasehold flat owners can make a business out of owning a large portfolio of freeholds, in the following ways :-
1. Ground rents – a lease is a form of contract and for English contract law technical reasons, many leases provide for payment of a yearly ground rent. This is effectively collecting money for nothing. Ground rents can be very low such as £100.00 per year but they can be higher. So, if it is possible to buy a freehold cheap from a freeholder who has no interest in remaining in that role, a decent yield can be gained. There can also be a windfall where ground rents have not been collected historically.
2. Lease extensions – according to the Office of National Statistics, there are over 800,000 properties where houses have been converted into flats in England. The majority of these properties are in London. Many converted houses originally had leases granted of 125 years or 99 years, whereas in larger blocks, lease terms now tend to be much longer, such as 999 years. As time passes, the lease term diminishes. Good news for freeholders is that most leaseholders, for technical reasons, will now seek to extend the lease back up to 125 years or longer before the lease gets down to 80 years. The premium to extend the lease is normally negotiated but based on an underlying formula as part of the long leaseholders statutory right to extend. Whilst amounts vary, typically the premium can be £10-20,000.00 resulting in a very nice windfall for the freeholder. According to James Swede who sepcialises in lease extensions at darlingtons Solicitors, in London, “lease extensions are now very common and freeholders often see to maximise their positions because what prompts a flat owner to discover the need to extend is when they are considering selling. In that scenario, the freeholder may have then upper hand because the fat owner needs to get things done quickly and not rely on the long drawn statutory process where there is no agreement on premium”.
3. Property management – if you manage to create a big enough portfolio of freeholds it makes sense to go into property management or maintenance or to potentially act as a broker making commission from builders or insurers. Some leases may allow a management fee and over time, properties will need structural maintenance and repair. Certainly, buildings insurance will need to be arranged on an annual basis.
4. In-house legal department – in many situations, such as where there has been default by a leaseholder in paying ground rent or service charge, where the lease needs to be extended or is otherwise defective (with older leases there are often issues with clauses which are now no longer acceptable to mortgage lenders. Leases can also need to be amended where plans are inadequate, inaccurate or where the leaseholder has altered the interior layout) the freeholder can insist on legal fees being paid. These fees can be between £500.00-£1,000.00 plus vat typically. It can be tempting for a company that owns a portfolio of residential freeholds to set up an in-house legal department, pay a lawyer a salary and potentially make a good profit as a result of these fees which will arise regularly where you have a large portfolio of freeholds.
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Daniel Peacock