RIP for RPI Ground Rent Clauses?

An increasing number of leaseholders are reporting they are being forced to pay extortionate RPI linked ground rents. Below Peter Wright at Hunters Solicitors tells Lawyer Monthly about a recent trend in new leases, whereby developers propose ground rent escalation at RPI clauses, resulting in a ground rent increase rate that can render some properties unsalable and stress that such clauses can be re-negotiated.

Throughout most of the 20th century, a “ground rent” was what it was originally supposed to be: a rent paid by a tenant to a landlord to reflect the value of the ground that was being let, ignoring any building on it. The term evolved to mean any low or nominal rent paid under a long lease that was granted for a premium, because a landlord who has already received a capital sum on the grant of a lease should not need to charge a tenant a full market rent as well.

But by the turn of the 21st century, a ground rent became something more than a convenient figure to indicate a landlord and tenant relationship without much bearing on the actual value of the land: it became a means for a landlord to continue to extract money from a tenant throughout the term of a lease, regardless of the premium paid at the date of the grant. The sums changed from being notional to significant and then outrageously high, even extortionate.

Houses owned on long leases with escalating ground rents which double every 10 years have become a well-publicised national scandal. Buyers of those houses failed to appreciate – or their solicitors failed to advise them – that a starting yearly ground rent of £100 might sound reasonable enough, but were it to double every 10 years over the course of a 999-year lease, the exponential function means that in 50 years’ time, the yearly rent would reach £3,200; in 100 years, £102,400; and by the end of the term of the lease, many millions of pounds per year. For the tenants, the leases were worth less than nothing: they were vast liabilities. It was only the eruption of anger in the popular press that prompted national house-builders to issue grovelling apologies and promise to remedy the offending lease clauses.

Ground rents which automatically double every 10 years may now have fallen out of favour but there remains another weapon in the developer’s armoury which has not: ground rents which increase by the percentage increase in the retail price index (RPI) over the preceding 10-year period. These clauses are invariably worded so that any decrease in RPI, no matter how unlikely, means that the rent will stay the same, and so the review is “upwards only”. The problem for prospective purchasers of leases is that most banks and commercial lenders insist on further investigation where a lease clause links increases in ground rent to RPI, and some of the smaller banks will refuse to lend against such a lease at all. Take Accord Mortgages, for example, part of the Yorkshire Building Society, which states that ground rent “must not be capable of being increased during the first 21 years of the lease” – a major problem when a lease provides for an RPI-linked rent review every 10 years.

The index hit a bottom of -1.6 per cent in June 2009 but has risen since then to 4 per cent today; and, with the end of central bankers’ unprecedented experiment in quantitative easing on the horizon, inflation is expected to rise even further – fears which strongly influenced the sudden downturn in global equity markets in early February this year. On 31st January, Mark Carney, the Bank of England governor, told the House of Lords economic affairs committee that he wants “a deliberate and carefully timed” withdrawal of RPI from its use in government contracts because “most would acknowledge [that it] has no merit” and contains “known errors”: in 2012, the Office for National Statistics (ONS) found that an obscure change in the way it collected the price of clothing exaggerated the difference between RPI and other measures of inflation, which shows prices rising at a slower pace. The ONS no longer recommends that RPI is used but it is the only statistic that the law requires the ONS to produce.

Evidently, pressure is building from the very top that RPI is a discredited measure of inflation which should be abolished to save the government money; but many employee pensions are linked to RPI, and unions would strongly oppose any attempt to shift to a less volatile measure which would reduce payouts, such as the consumer price index (CPI) or the ONS’ preferred index, “consumer price inflation including owner-occupiers’ housing costs” (CPIH). A similar conflict appears when new leases are being negotiated: tenants would like to remove RPI and substitute an alternative, or even remove rent review provisions entirely; but landlords would rather keep the flawed, more lucrative measure.

The “leasehold houses” scandal, and the equally vociferous opposition to excessive levels of remuneration for directors of national house-builders, showed that developers cannot hide indefinitely when the wind of public opinion is blowing against them. Anyone proposing to become a tenant under a new lease should therefore be willing to challenge an RPI-linked ground rent clause. Whereas at the market’s height a few years ago a developer might have rigidly insisted on retaining such a clause – safe in the knowledge that another buyer who would accept it was likely to be waiting in the wings – the subtle shift of power to buyers since then means that there is nothing to be lost from a challenge and, in an environment where developers are under increasing public pressure to grant fair leases and to do away with RPI, everything to be won.