Negative equity threat for leasehold properties

Up to 1.43 million homes in England and Wales are at risk from shortening leasehold terms – threatening borrowers and lenders with negative equity.

The warning comes from e.surv, the largest chartered surveyor in the UK.

Once property with a leasehold tenure – which accounts for 10.1% of residential housing stock in England and Wales – has less than 80 years until it expires, the value of the property begins to fall as lenders won’t grant a residential mortgage on it.

The value of the property plummets rapidly once the lease runs down to below 60 years.

Unless the lease is renewed – which costs more the shorter the lease is – the value of the home can drop rapidly enough for the owner to fall into negative equity and become trapped in the home because it becomes impossible to get a mortgage.

Richard Sexton, director of e.surv chartered surveyors, said: “Around 90% of property in England and Wales is freehold, meaning the home owner also owns the land. But the remaining 10% is leasehold, where the owner of the property effectively rents the land for a nominal sum.

“The length of the lease has a direct bearing on the value of the property, and most people aren’t aware that a shortening lease term can erode thousands of pounds off the value of the home.

“Most leases are very long – up to 900 years in some cases – but there are plenty which are much shorter.

“Once a lease has less than 80 years to run, the value of the property begins to fall and picks up speed the closer it gets to expiry. The potential consequences are nightmarish for the owner and the mortgage lender.

“Both the lender and the owner can fall into negative equity, the property becomes unmortgageable, and is therefore impossible to sell to anyone but a cash buyer. This traps the lender and the borrower with a toxic asset that is losing value by the day.

“In the worst case scenarios, the borrower is unable to move home, the lender is forced to repossess the property and is stuck with an asset that has plummeted in value. It is a big danger to a lender’s leasehold back book.”

He said flats are particularly at risk because most UK flats are leasehold rather than freehold. Of the 1.43 million leasehold properties in the UK, 817,000 are flats, while the remaining 612,000 are houses. This means inner city urban areas are disproportionately affected by the problem of shortening lease terms.

Sexton warned that borrowers with interest-only mortgage borrowers are most at risk. If the borrower is just servicing the mortgage on a leasehold property, once the unexpired lease runs below 80 years the value of the property falls close to the outstanding balance of the mortgage and shortly afterwards can fall into negative equity

Since 2002, there have been 1.28m interest-only loans granted for house purchase loans which have no repayment plan. This represents 14% of total house purchases over the last decade.

London and the North-West have the greatest exposure to shortening lease terms. Across the UK, 10.1% of total residential housing stock is leasehold, but in the North-West and London 23% of all residential property is leasehold.

As well as the threat of negative equity, failing to help mortgage borrowers renew the lease on their property – and failing to identify customers with short lease terms and alerting them to the problem – leaves lenders open to accusations that they have treated their customers unfairly.

Sexton said: “To protect their lease back book, lenders need to securitise and measure the value of the home – because it may be worth much less than they expected. Some lenders could have a big block of borrowers on their books that are affected by the problem. Gone unnoticed, this block would be a ticking time bomb.

“The consequences of not acting are potentially very serious. Lenders will come under intense Treating Customers Fairly scrutiny. They may be forced to repossess homes which are nigh on impossible to shift. And that’s not to mention the hit their balance sheets will take.

“It’s important lenders notify their customers if there may be a problem. They then need to offer them advice on how to go about extending the lease.

 “Shortening lease terms needn’t be a problem as long as the lender and the consumer are made aware of it in good time. A lease extension can cost as little as a few thousand pounds, and buying the freehold costs even less.

“Applicants shouldn’t accept the first sum quoted by their landlords but they will be responsible for their own costs and those of the freeholder. The shorter the lease becomes, the more expensive it is to extend. It’s an issue that needs to be tackled early or else it can snowball.”