The Law Commission’s proposal for reforms to commonhold

The Law Commission has published its proposals for the alternative to leasehold ownership and set out reforms to commonhold, introduced by the Commonhold and Leasehold Reform Act 2002, to make possible ownership of freehold flats.

Commonhold is the ownership of a single property or unit within a development which is owned by a commonhold association. It is a type of freehold and most likely to be used for flats but can be used for freehold houses and non-residential property. Each unit holder is a member of the commonhold association which is responsible for the day to day maintenance and running of the development.

Since the introduction of commonhold, there have been fewer than 20 commonhold schemes in England and Wales. The general consensus being that commonholds do not appeal to property developers who wish to hold onto the income stream of ground rents, extension premiums and other leasehold income and are not attractive to lenders. By adopting a one size fits all approach, the current commonhold regime is seen as too inflexible.

The Commission’s overall aim is to reinvigorate commonhold as a workable and preferred alternative to leasehold for both existing and new homes to remove abuses in leasehold schemes such as escalating ground rents, excessive service charges, poorly maintained buildings and high management fees and to give home owners greater flexibility about how their building is run and what services are to be provided.

The Commission makes recommendations about how commonholds can be made more appealing to developers, lenders and existing leaseholders.

The government has been criticised for not encouraging the use of commonhold and in order to widen its use the Commission suggest that the government needs to decide whether to ban the sale of leasehold flats completely, making it compulsory for them to be sold on a commonhold basis or whether developers and property owners should be left to choose whether to use commonhold or leasehold, as is the case now.

 Without a ban it is difficult to see why developers would stop selling leaseholds except where they consider that such sales will affect their brand and reputation. The government intends to ban the sale of leasehold houses and restrict ground rents to zero, subject to certain exceptions, so this sort of reform, if adopted, should not come as a complete surprise to developers.

The new proposals also seek to address the constraints with the existing commonhold law, which does not permit mixed residential and commercial schemes or cater for shared ownership leases, equity release products or the Help to Buy Scheme.

The report recommends that it should be possible for existing leaseholders to convert to commonhold if the freeholder consents or if it does not consent the leaseholders make a “collective freehold acquisition claim” to enable conversion. There should be no requirement to obtain the unanimous agreement of all the leaseholders, the freeholder or any mortgage lender. To align with proposed changes to collective enfranchisement, the Law Commission recommends that any building that has 50% or more residential use, should be capable of being converted to commonhold if sufficient long leaseholders of the residential flats wish to convert. Unlike under the existing commonhold system, the freeholder will not be required to consent to the conversion.

For commonhold to succeed, the government will need to get lenders on board. There has been little or no appetite for lenders to fund commonhold properties to date and the Commission has issued an open letter to lenders setting out how it has addressed lenders’ concerns. The Commission argues that it proposals provides improved security for lenders – there is no risk of a unit being taken back by a landlord and unlike lease, a commonhold is not a depreciating asset. It is recommended that mortgages over existing leasehold properties automatically transfer to the commonhold unit if there is a conversion without the need to obtain the lender’s consent, streamlining the process. Lenders will want to take a very close look at the detail of what is proposed before they get on board and it is recognised that the government will need to work closely with lenders to achieve this. The Law Commission has stopped short of recommending that existing mortgages over leasehold flats should transfer automatically to the new commonhold title that will be created on conversion.

Guidance is provided to developers of mixed-use schemes about how to separate the management of different types of commercial and residential interests, to enable commonhold to be built in phases and sold off whilst the developer retains control of the site still under development.

Statutory rights associated with leasehold, including the rights to challenge service charge costs and to be consulted on certain works, would not apply to new commonholds or buildings which have converted to commonholds.

It is recommended that all commonhold associations must have a reserve fund. The contributions to the reserve fund should be held on statutory trust and determined by the commonhold association by a simple majority of those voting at the same time as the contributions to the shared costs are approved.

Developers may argue that making commonhold mandatory will increase the price of flats because they will not retain any residual income either through retaining the freehold or selling the ground rents. [It has been suggested that developers may look to recover some of the losses through freehold ownership via those schemes which are required to pay a service charge for the maintenance of amenity areas by charging management fees or by imposing covenants requiring consent fees to be paid for alterations to houses.

The Commission addresses the need for there to be a cultural change for all participants in the housing market and a re-think of the assumptions on which the market currently operates. It will be interesting to see if this happens, particularly with everything that the property industry is currently going through. One thing is clear from the Law Commission’s report. It does not think that leasehold ownership of flats is fit for purpose and needs to replaced by commonhold.