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Investing in UK Residential Ground Rents

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By : Chris Horne    99 or more times read
Many landlords are attracted to investing in property because they feel their money is always safe in ‘bricks and mortar’.

However, in these riskier times I decided to look at an alternative investment. One based around a strategy, which suggests that actually investing on the land on which these bricks and mortar sit may be the better option. What we are talking about is investing in ground rents.

What are ground rents?
In very simple terms ground rent is “the rent paid by owners of the land on which a building sits”. In most domestic property there is a single owner of a property the freeholder. However, where property has been developed for apartments for instance the ownership is often split into freehold and leasehold interests. The leaseholder will generally own the bricks and mortar i.e. the apartments. The freeholder retains the ownership of the land. In return for the use of the land on which the building is located the leaseholder is required to pay the freeholder a small annual rent. This is the ground rent. This system has developed historically through the system of Common Law.

Investors looking at low risk investments
As the economy has slid into depression, investors are increasingly seeking out low risk investments paying high levels of income. This is an investment profile that fits ground rents where the owner and landlord ultimately has the sanction to take back the freehold of the land if the leaseholder fails to pay their rent. This is a big incentive for the leaseholder to keep paying the very small ground rents and not to default on the lease. It also gives the landlord a great deal of security as failure of the tenant to make payments could ultimately result in the landlord taking the land back and then making a big capital gain on the reversion of the freehold interest to them. A no lose scenario.

Many landlords are put off by the slightly unusual nature of these investments. But James Cannon, Savills head of commercial auctions explains ground rents are the ‘closest proxy to investing in bonds that the property industry offers’. “Too many investors overlook the huge returns on offer”, says Sinead Cruise a journalist for Property Week recently commented.

What type of income should I expect?
Income returns from these investments are not stellar however compared to the 0.5% available to many investors with cash they look very attractive. Ground rent investments produce an annual income of around 6% although this varies considerably depending on the time period to reversion. Where a landlord is prepared to sweat the assets these could be several percent higher taking the annual income to around 10%. This is because landlords are often responsible for ensuring that the buildings have appropriate landlord building insurance.

In these cases a landlord will often have the opportunity to gain an introducer's fee from the landlord insurance broker.

Ground rent potential upsides
Gary Murphy a partner with Allsop and a residential auctioneer who sells many ground rents explains the potential upside of ground rent investments: ‘Ground rents can be both dry and active investments, depending on the type of ground rent you buy and your appetite to sweat the asset.’
Murphy points to three main angles of opportunity that investors have exploited: lease extensions, development and management potential, and the chance to drive income from commissions paid to landlords by the insurers of the property.

Lease extensions
Landlords can potentially make money from their ground rents by granting them an extension to the length of their leasehold. These extensions are particularly lucrative when the length of the leasehold drops below 60 or 70 years because many lenders will then refuse to lend against a leasehold property making them un-mortgageable.

Development and management
The second angle is development and management. Murphy claims that investors have made fortunes from ground rents that cost them a fraction of their initial outlays. ‘Some agreements state that the leaseholder must obtain consent of the freeholder if he wants to conduct any refurbishment of the property,’ he says. ‘If the occupier wants to, say, knock a wall or extend a kitchen, the freeholder is within his rights to ask for some incentive.’ Other ground rent investors have taken full advantage of flat roof space or redundant garages to build penthouse flats or develop entire new properties.

Portfolio Development
There are a number of specialist ground rent companies that are interested in buying portfolios of ground rents to add to their portfolios. The companies are often backed by institutional money giving them large budgets to acquire portfolios of ground rents. In October last year, Savills sold the biggest portfolio of industrial property ground rents in more than five years. It attracted a range of institutional bidders, including Prupim, which landed the portfolio for £59m, reflecting an initial yield of 3.65%. Disposal of these portfolios can often provide a landlord with a large capital return after many years of carefully putting together a portfolio.

Where do I buy ground rents?
There are a number of ways for a landlord to buy ground rents. Many landlords will have come across the sale of ground rents in the auction rooms which specialise in selling these kinds of niche property investments.

The other alternative is to buy a ground rent through a specialist ground rent broker. One such specialist broker is the Ground Rent Business based in Essex. The brokerage, run by Richard Irving has tens of ground rents available starting at a few thousand pounds up to many hundreds of thousands for leases paying higher rents and with greater reversion potential.

For those landlords who do not want to get involved in the direct management of their ground rents it is possible to invest in a number of specialist funds.

Things to consider when looking to buy a ground rent:

  • The length of the lease, leases of over 150 years will give little opportunity for an uplift as reversion gets closer, 125 years and below offers some reversionary uplift.

  • Does the lease give the landlord opportunities to ‘sweat the assets’ by arranging insurance and providing block management?

  • What are the provisions in the lease for rent increases?
  • What are the development opportunities of the site?
Chris writes for the The Landlords Homepage which includes Free Property Letting Software, free tenancy agreements, magazine, book, links aimed at the UK Buy to Let Market.

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