Blocks of flats – what happens to the freehold?
One of the major decisions that developers need to make when converting an existing building into flats, or building a new block of flats, is what to do with the freehold. New flats are always sold on long leases and the freehold remains with the developer unless he adopts an alternative strategy.
The freehold is an asset, because it carries the right to receive rents. These can be as high as £200/300 a year but £50/100 is more common. Ownership of the freehold is also a liability because it carries obligations in relation to repair of the structure, exterior redecoration, maintenance of outside space, and insurance of the building and boundary walls. A freeholder can recover these costs through service charges, and charge a management charge, but the law relating to the recovery and collection of service charges is complex and very much in favour of the leaseholders who have to pay it.
The options for a developer are:
- Retain the freehold
This gives the developer the right to collect rents but is only worth doing if the rents make it worthwhile. If there are only three flats in the building and the rents are set at £5 per flat then the benefit of the rents is offset by the hassle of organising maintenance, repairs and redecoration, and buildings insurance. If the rents are significant, and you pass the management to agents, this is worth thinking about, but most developers are not interested in doing it themselves – and should not try!
- Sell the freehold
There is a definite market for freeholds. Ten flats at rents of £100 a year per flat (guaranteed) yields £1000 a year. The sale price would depend on interest rates and how much you would need to invest to earn £1000. You have to find your buyer, then offer the freehold to the leaseholders at the same price. They then decide whether they wish to step in, but they are not entitled to a discount so you get full value whether you sell to an investor or the tenants.
- Transfer to a tenant’s management company
This is popular with buyers and therefore often encouraged by estate agents. The developer sacrifices the rent and the capital value of the freehold but gains in terms of ease of sales – possibly – and because his liability ends.
Steven Leigh, partner, has 40 years of experience in property work and has set up many flat schemes. Contact him on 01752 203500 or email email@example.com if you would like further advice.
Steven Leigh, partner