The impact of ground rent reforms on Integrated Retirement Communities

The Leasehold Reform (Ground Rent) Bill, which limits ground rents in new residential long leases, received Royal Assent on 8 February 2022. It is part of a wider package of leasehold reforms that the Government intends to implement to modernise the residential leasehold system in England and Wales.

What are the main provisions of the Leasehold Reform (Ground Rent) Bill?

When it comes into force, the legislation will restrict the payment of ground rents in certain residential long leases of a single house or flat granted for a premium in England and Wales. A long lease is one granted for a term of more than 21 years.

The effect of the legislation is that it will not be possible to demand ground rent in the majority of new residential leases. The landlord may only demand what is known as an annual “peppercorn rent”, which has no financial value and is effectively zero.

Will existing leases be affected?

No. The legislation will only apply to new leases which are granted after the legislation comes into force. It will not have a retrospective effect on existing leases.

What are the penalties for non-compliance?

Where ground rent is demanded in respect of a qualifying lease in contravention of the legislation, a breach will occur if a landlord does not return any payment to a tenant within 28 days of receipt. A leaseholder also has a right to apply to the First-Tier Tribunal (Property Chamber) in England for a declaration that a term in a new lease to which the legislation applies reserving a prohibited ground rent is replaced by a peppercorn rent.

In addition, there are fines for non-compliance of up to £30,000 per qualifying lease. Enforcement will be governed by local authorities and trading standards.

How will the legislation affect integrated retirement housing?

The Government had initially indicated that integrated retirement properties would be exempt from the remit of the Bill, based on evidence that the supply of such housing would be negatively impacted if no exemption were granted for the sector.

In a departure from this position, the Housing Secretary announced in January 2021 that zero ground rents would also apply to integrated retirement leasehold properties. The Government’s rationale for this was to ensure that purchasers of these properties have the same rights as other homeowners and are protected from “uncertain and rip-off practices”. In light of the U-turn, there will be transitional provisions so that the legislation will only apply to new leases of these properties granted after 1 April 2023.

Unlike most standard residential developments, ground rents in this sector (which can be as high as £500 per year) offset some of the development costs of communal areas within the Integrated Retirement Community. Such communal areas cannot be sold or rented out and can occupy as much as 30% of the total floor space of the whole site. Operators will therefore need to recover this shortfall elsewhere.

Lauren Hetherington of the Living Capital Markets (Healthcare) team at JLL says that “Since the announcements that ground rents could no longer be applied to retirement schemes, operators have proven resilient by modifying their income streams and business plans. This has contributed towards the rapid increase in the number of operators providing, or looking to provide rental options for residents, as well as shared ownership. Others are looking to implement event fees within their business models to make up for the loss of ground rents or rely more heavily on monthly management charges.

This diversification of income, or transitioning to a more operational model is proving attractive to investors as it reduces the risk of relying on one income source, and is helping to create a more institutional investment market for our sector.”

How has the Integrated Retirement Communities sector responded?

ARCO (the Associated Retirement Community Operators, which represents the largest coalition of private and not-for-profit operators and stakeholders providing integrated retirement housing) issued a press statement on 30 November 2021 stating that “ARCO supports the Government’s efforts to modernise the leasehold system and make it fairer and more transparent for consumers” and that ARCO “[does] not believe that ground rents are essential for the future of the growth of integrated retirement communities in the UK”. 

Others have suggested that any potential increase to purchase prices to compensate for zero ground rent could affect the supply of integrated retirement housing, particularly at a time when the Government has recognised that housing-with-care can help relieve pressure on the NHS and free-up homes for all ages.

Lauren Hetherington from JLL says that “In order that the new ground rent legislation doesn’t impact supply, we would urge the government to utilise the recently announced Housing With Care Task Force to legislate the sector and event fees alongside operators, developers, funders and advisors. By legislating the use of event fees and all income streams associated with Integrated Retirement Communities, we would anticipate that there will be an increase in supply as operators will have a set framework to develop and operate within. This will allow security within their operations and income, and provide residents and investors with certainty around the product offer.

The ground rent income has to be replaced within operators’ models, and this is where event fees, rents and other operating charges are coming into play. Operators knew that the legislation was coming, and therefore transitioned their business since the initial announcements, and should therefore have less of an effect when the legislation is actually implemented.

Overall, the legislation has demonstrated the Retirement Community sector is very resilient to change, and the forced removal of ground rents has actually reflected positive change.”

How will the changes affect lenders operating in this space?

It is unlikely that lenders will need to make any changes to their credit analysis to reflect the new legislation. We have not seen lenders give weight to ground rents in their financial models on the transactions that we have advised on in the last year. Both CRS and JLL have found that most lenders already started transitioning their credit analysis away from ground rents when the legislation was first proposed and have instead focussed on developing their understanding of event fees, rental models and alternative structures.

What will happen next?

The main provisions of the legislation (including the ground rent restrictions) will come into force on the date specified by the Secretary of State in regulations. Government Minister Lord Greenhalgh has committed that it will be fully commenced within six months of Royal Assent, save in relation to integrated retirement home leases where the sector has been given additional time to transition to 1 April 2023.

For more information, please do not hesitate to contact Cara Whiffin (Banking and Finance), Lauren Fraser (Real Estate) or your usual Charles Russell Speechlys contact.