On 12 May 2021, the Leasehold Reform (Ground Rent) Bill (Ground Rent Bill) was introduced to Parliament. The much-anticipated Ground Rent Bill, if and when it receives Royal Assent, will implement the government's objective of capping ground rents in new, long residential leases at a peppercorn. It will also represent a significant step towards the wider government aim to overhaul the residential leasehold system in England and Wales, with significant implications for developers, investors and tenants.

Summary

Over recent years, there has been a lot of speculation around leasehold reform. A focal point has been ground rent.

The term "ground rent" refers to a periodic rent payable by leaseholders, and which creates an income for landlords of let residential buildings. While the reservation of a ground rent is common, in recent years concerns have been raised about the future level of some ground rents following their review under certain leases.

Under the Ground Rent Bill:

• Prohibited Rents will be introduced, and the general rule (subject to exceptions below) will be that the only rent permitted under Regulated Leases will be a peppercorn per annum (essentially outlawing demands for monetary rent payments in most new Regulated Leases);
• if a Regulated Lease attempts to reserve a Prohibited Rent, then the Ground Rent Bill will apply so that the landlord will only be able to collect the amount permitted under the Ground Rent Bill; 
• landlords could face fines of between £500 and £5,000 if they charge Prohibited Rents (with scope for this to be more in the event of multiple breaches); and
• landlords who have charged Prohibited Rents and go on to sell their interest in a building could still face financial penalties for up to six years after the event.

Regulated Leases

A lease will be a Regulated Lease if the lease is:

• a long lease* of a dwelling;
• granted on or after the relevant commencement day** (or granted pursuant to certain agreements exchanged before the relevant commencement day); and 
• not an Excepted Lease***. 

*The majority of long leases captured by the Ground Rent Bill definition will be leases for a term of 21 years or more, but long leases will also include those granted with a perpetual ability to renew, and any granted for a lifetime or until the marriage or civil partnership of the tenant which automatically take effect as 90-year leases pursuant to section 149(6) of the Law and Property Act 1925.

**The relevant commencement day will be the date on which the Ground Rent Bill comes into force. It is not expected to have retrospective effect.

*** The list of Excepted Leases is fairly short, comprising business leases, statutory lease extensions, community housing leases and home finance plan leases (in each case, where certain conditions are satisfied). 

Prohibited Rent

A landlord of a Regulated Lease must not require its tenant to pay any Prohibited Rent. It will be an offence:

• to ask for payment of Prohibited Rent; and/or 
• if the landlord receives a payment of a Prohibited Rent and fails to refund the money to the tenant within 28 days of receipt.

As a general rule, Prohibited Rent will be any rent over and above a peppercorn per annum. The following are exceptions to the general rule:

• Shared Ownership Leases: where a Regulated Lease is a Shared Ownership Lease (i.e. where the tenant's interest in the Lease is less than 100%), the Prohibited Rent will be any rent that exceeds:
  • a peppercorn in respect of the tenant's share in the Lease; plus
  • any rent that is payable in connection with the landlord's share of the lease (which is uncapped).
• Leases replacing pre-commencement leases: where a replacement lease (which is a Regulated Lease) is granted before the end of the term of a pre-commencement lease, the ground rent payable for overlap will be the amount reserved by the pre-commencement lease. Thereafter the rent will either be determined by the general rule, or the shared ownership exception above, as applicable.

If, despite the Ground Rent Bill, the Regulated Lease reserves a Prohibited Rent, then the Ground Rent Bill will take effect so that the relevant term will be treated as reserving only the rent permitted under the Ground Rent Bill.

Enforcement

Local Weights and Measures Authorities and District Councils will be responsible for enforcement of the Ground Rent Bill.

Under the Ground Rent Bill, the enforcement authority may:

• take action against a current or former landlord for charging tenants a Prohibited Rent. The financial penalty will be between £500 and £5,000;
• if a tenant has made a payment of Prohibited Rent, take action against a current or former landlord, or persons authorised to receive money on behalf of the same, to require a refund to be paid to the tenant. 

Timings

It is likely that the Ground Rent Bill, if and when it receives Royal Assent, will take effect in relation to different categories of lease at different times. Despite some suggestions of making the provisions retrospective, it appears that it will only have prospective effect and will only capture new leases.

There had been discussion around excluding retirement leases from the cap on ground rents. It is now clear that retirement leases will fall within the scope of these provisions. However, the Ground Rent Bill envisages that the earliest that the Act would come into effect for leases of retirement homes will be 1 April 2023.

Ongoing considerations for developers and investors

The market has already seen a pre-emptive move away from ground rents, with some developers already adopting peppercorn ground rents. However, now that the Ground Rent Bill has been revealed, developers and investors will be interested in the following key points:

• It would appear from the Ground Rent Bill (as introduced) that, if a developer has entered into an agreement for lease before the Act comes into force, they will be able to demand the ground rent reserved by the Lease (uncapped). However, developers should be aware that further measures could be introduced to cap ground rent in order to target the government's wider leasehold reform aims.
• Leases granted pursuant to existing options and rights of first refusal after the Ground Rents Bill becomes law will not be exempt from the provisions of the Ground Rent Bill, notwithstanding they are derived from pre-commencement documents. Presumably, this is because in both cases the person triggering the grant of the lease will have a choice whether to proceed or not.
• If a lease that pre-dates the implementation of these provisions is varied after implementation of the Ground Rent Bill to such an extent that it would amount to a surrender and re-grant, the new lease that arises will be caught by the cap on ground rents.
• The definition of rent is potentially very wide as it "includes anything in the nature of rent, whatever it is called". Developers will be concerned that this definition could catch the payment of sums that should not out of principle be covered by the Ground Rent Bill, such as estate and building service charges and insurance rents. We would not expect this to be the aim or intention of the Ground Rent Bill and would hope that this definition is clarified further. In the meantime and in any event, care should be taken when drafting leases which may become Regulated Leases.
• The Ground Rent Bill would allow action to be taken against former and current landlords. This will become an important due diligence point in acquisitions and disposals of buildings with a residential element.
• When setting up a residential development structure, developers should carefully consider their exit options for when the units have been sold to occupiers. While currently it is possible to present a ground-rent producing reversion to investors, that option will eventually be closed down for developments with new residential leases granted after the Ground Rent Bill becomes law.