Should I Buy a Short Lease Property

Should I buy a Short Lease Property?

All of a sudden, more people are buying short lease properties. In this article I will look at why, what the risks are and whether this is a smart move.

Regular readers will know of my preference for houses over flats partly rests on the bleeding obvious: that builders can build up into the air, but they cannot create more land – only God or very big seismic movements, like the one that caused the Japanese tsunami can do that!

So, houses with gardens will always be in limited supply in cities and towns, whilst flats in the air are in potentially endless supply. The simple laws of supply and demand and the beautiful market clearing mechanism of price does the rest!

That’s not to say all flats are bad investments. Some flats are very good investments and I do have some in my portfolio. If you want to find out which kinds of flats can do well, that’s another topic – book a consulting session with me.

Right now too, a lot of higher rise flats are having trouble with cladding and other fire issues, following the Grenfell disaster. This will rumble on for some time yet as the government continues to dither over who is going to pay. I have covered the cladding story here recently – check out recent blogs.

But there is a bright light on the horizon for flats and leasehold in general.

Well, possibly there is a bright light. We should not get too carried away right now.

Leasehold flat extension system could change

The possible bright light comes with the news that the government has promised an overhaul of the leasehold system in which leasehold owners, (nearly all leaseholds are flats, but there are a few houses too), will have the automatic right to extend their leases to 990 years and the system of ground rents will be broken up.

This change would ensure that the cost of lease extensions are reduced substantially.

What happens now, under the current system, is that the shorter your lease is the more you have to pay to extend it. And if it falls under 80 years the price really rises as something called “marriage value” kicks in. Plus, for shorter leases it will also be impossible for anyone to buy it using mortgage finance. Under 80 year lease properties are all bought by cash buyers.

This means very short lease properties can be bought very cheaply indeed, reflecting the fact that any buyer will, sooner or later, have to pay a lot of money to the freeholder to extend the lease to prevent the ownership reverting to the freeholder.

But even under the current system there are good reasons why professional investors buy short lease properties.

First, they don’t cost much for the obvious reason the buyer will, sooner or later, have to fork out to extend the lease. Second, there is less stamp duty to be paid. Third, there tends to be less competition from other buyers.

But recently, a one bed flat in South Kensington in London with just 11 months remaining on the lease sold at auction for a whopping £127,000.

This is because the buyer is clearly hoping the government will indeed change the rules in time and he/she will have a bargain because the cost of extending the lease will crash.

But is that too hasty?

I think so. Maybe the buyer of that flat knows something I don’t – i.e. that the proposed changes are definitely going to happen.

Maybe they will, but I’m not sure they will happen in the 11 months left on that particular lease, because one thing we know about governments, especially the government of Boris Johnson, is that dithering is the watchword and he likes big announcements on which he then quietly fails to deliver on.

Short lease flats rising in value

But this buyer is not the only one. Some experts have noticed a rise in the value of many other short lease flats coming to auction – as buyers take a punt that the changes will indeed come in and lease extensions will become cheaper in the future.

So far I cannot find many reports of longer lease flats – say those at 90 or 95 years – showing larger than expected price rises – but that could be due in part to the fact that the ongoing cladding/fire issues are pulling in the other direction, obscuring the picture. More research is needed on this, perhaps by looking at lower rise flats that definitely do not have cladding issues.

People thinking of buying short lease flats are taking a risk. In my view, one of the biggest risks is that nothing will happen at all – or that something will happen but it will not be all that much.

Why the scepticism?

Because there are some very powerful voices ranged against this plan. The huge landowners of estates in London with very expensive leasehold property which are bringing in big money from ground rents and lease extensions have a lot to lose. Organisations like the Grosvenor and Cadogan Estates come to mind.

History shows many past attempts at reform of leasehold which have failed to deliver much – the commonhold concept being one of them.

I would not hold your breath for big change on this one.

If change comes it will be very slow coming and will likely be watered down, so I wish all the best to the buyer of that 11 month lease flat. That said, even if he has to increase the lease length at great cost under the current system, even the rising hope that some positive change is coming for leaseholders will have increased the actual flat value anyway.

Watch this space.

To read some other articles on leasehold that we have covered over the years see the tags at the bottom of this post and click here: Leasehold Archives – Letting Focus

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