Are Lease Extensions a Good Investment Strategy?

The lease extension process is something that a lot of investors decide to avoid, as it is a little more complex than the more straightforward projects. But with a little understanding, and knowing where to start, you might find some great investments that others miss.

This applies to leasehold properties, in which the buyer buys the right to occupy the home for a specified length of time, the lease term. This is opposed to a freehold, in which the buyer owns the land plot and the property built on it. Leaseholds are common for flats and similar properties, where the larger property remains with the freeholder and parts of it are sold as leasehold to the occupiers.

First, let’s look at the statutory lease extension legislation. The Leasehold Reform, Housing and Urban Development Act 1993 permits tenants to extend their lease for 90 years (plus the remainder of the existing lease term) at a peppercorn ground rent, by paying a premium.

So why is this a good idea? As the remaining time of the original lease term gets shorter, the cost of extending the lease increases. If the remaining time on the lease is less than 80 years, then marriage value is payable to the landlord.

If the remaining lease is less than around 70 years, a tenant will begin to find it difficult to sell, as lenders may not offer mortgages if the lease term gets this low.

What does this mean?

The premium is the amount paid for the lease extension, and is worked out based on several factors, including the remaining term and the loss of ground rent. This premium goes up if the lease only has 80 years remaining, which is where the marriage value comes into play.

Marriage value reflects the potential for increasing the value of the when the new lease is granted. This value is shared equally (hence “marriage”) between landlord and tenant as profit. How this is assessed depends on local property prices and knowledge to judge how the value will increase due to a new lease.

There are a few requirements for a property to qualify for a lease extension. These are fairly strict and limit the types of property that can be leased in this way.

The flat must have been owned for at least 2 years by the same owner, as per the Land Registry, and it must be held under a residential lease of over 21 years.

The property can not be a business lease, or part of a charity. Lease extensions can also not be applied to buildings within cathedral boundaries, or on National Trust or Crown land.

How Does a Lease Extension Occur?

The Extension process starts with a Section 42 Notice being served. This is, essentially, a form that states the Lease Extension process has begun. Speak to a solicitor to arrange this Notice, and to ensure it is written correctly. If there are any mistakes or spelling errors, the Notice could be rendered invalid, so it is always best to have it checked and double-checked.

The Notice must also be signed by the registered proprietors of the property. It cannot be signed by someone under power of attorney. If the Notice is served by a company, then the company should have a procedure to follow in this circumstance. The company solicitor will be able to help here.

Service a Notice accomplishes several things. Alongside officially notifying the landlord of the intent to extend the lease, it also sets the valuation date of the property. This fixes in place values such as the present and future value of the property, based on the time until expiry and other factors.

The initial response from the landlord will most likely be an acknowledgement of receipt of the Notice, though if they are competent that is all it will be. Nothing else in the notice will be confirmed or agreed by the receipt.

The next stage is for the landlord’s solicitor to request up to date copies of the property documentation, such as leasehold title, lease documents, and so on.

The landlord then has the opportunity to submit a counter-notice. This is to either accept the claim as valid, or to deny the claim. Denials are usually based upon errors in the notice, such as misspellings or other inaccuracies, but can also be given if the premium is too low.

The process then becomes a negotiation between the two parties. The matter can be referred to the FTT if the parties cannot come to an agreement on the premium payable, but this is rare.

Final Word

As with any property strategy, the more you know, the better your chances for success.

The main thing to takeaway from this article is that, if you are looking at lease extensions as a potential strategy, make sure you involve experienced solicitors and professionals. Creating a legally correct Section 42 Notice may be the most important step of the process, and getting that right will save a lot of headaches.

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