News on The Block issue 27, May 2006

Freehold acquisition: silver bullet or poisoned chalice?

Flat-owners up and down the country are saying this because they are sick and tired of poor management, rip-off buildings insurance and spiralling management charges. But acquiring the freehold for your block is not the “silver bullet” cure-all that it may seem at first sight.

I have worked with literally thousands of flat-owners that are delighted when we explain the process for buying out their freeholder and becoming “masters of their own destiny”. “What could be better?” they think. This money-grabbing crook that causes them nothing but trouble seems a remote presence that sits in an ivory tower, oblivious to their daily traumas. But acquiring the freehold to the block is not only a very major legal and moral obligation, a potentially expensive, stressful and tortuous process but may actually not be the panacea so many leaseholders imagine it to be. Increasingly there is the realisation that a simple ‘bulk’ lease extension is quicker, cheaper and offers less obligation in the long run.

Sure, the law is on your side as a flat-owner, empowering you to buy the freehold. The 1993 Leasehold Reform, Housing and Urban Development Act enshrined your rights to extend your lease or buy a block’s freehold whether the freeholder wanted to sell or not. And the 2002 Commonhold and Leasehold Reform Act removed some of the more onerous conditions making it easier for flat-owners to release themselves from the shackles of leasehold all the sooner. However, so many of our clients seem intent on blundering blindly down the cul-de-sac of freehold acquisition when in fact lease extension would be a better option in their particular cases.

So often less experienced practitioners of “leasehold enfranchisement” such as surveyors, solicitors and those formerly involved the building industry present a “one size fits all” approach. Certainly the law empowers flat-owners to buy their freeholds, but it is the human and practical angles that are so often overlooked.

But all this is irrelevant if we cannot get one or more of the flat-owners to be directors of the new freehold company for example. Surely, SOMEONE would step forward for this fairly light duty, one might think? But, sitting in lounges up and down the country, I have found that this is frequently one of the major obstacles to a freehold acquisition going forward.

In many cases, especially outside the major cities, flat-owners are not entrepreneurs and business people. They are too busy to take on another big job because they are tired after work and have busy weekends. This is what we hear day in day out.

As such, they see a directorship of a company as a huge duty with commensurate risks. “What if it does an Enron and I go to prison?” they might think (they can of course pay for directors’ liability insurance to ease this issue). And they rightly appreciate that, if they do not make their returns to Companies House, the company could be struck off. AGMs need to be organised. Plus the directors need to be sensitive to the many different types of needs and personalities of people in their blocks such as elderly people with plenty of time on their hands and small scale investors that are impatient.

Unfortunately, “real people” don’t want to take responsibility outside their regular lives, and want the mythical “someone else” to do it. When I bought my block’s freehold almost ten years ago, I had no such fears because I was running my own company. But as soon as I began helping other people who wanted to buy their freeholds, it became apparent that most flat-owners want to wave a magic wand to resolve the issues they may be suffering with their blocks.

But let us assume that one or two conscientious flat-owners in a block decide to become directors. Now they realise how they become the focus of their neighbours’ frustrations and what a thankless task running a block is. Of course, when it is all over they can appoint a managing agent for the nitty gritty jobs, but the freehold company directors do still get it in the neck when things go wrong!

I am painting a gloomy picture of course and not all blocks have such an attitude. We have an enviable record of gaining high levels of participation in freehold acquisitions. Usually around 80% and in some blocks we have been impressed by how many flat-owners took part in the freehold acquisition. 59 flats out of 67 (Bexley), 41 out of 52 (Haywards Heath) and 16 out of 18 (Bermondsey) are recent examples.

The reality is that a freehold acquisition is simply very unlikely to proceed if well over 60% don’t pitch in. The 50% threshold may be a legal limit, but the practicality is that the participants are clubbing together to buy one very valuable asset that could be worth £500,000 or £10 million. And, put simply, the more people that participate, the cheaper it is. But the realisation of the scale of the task and the sheer numbers make the average flat-owner sit up and think.

With lease extension each individual is undertaking a transaction relating to their flat only. They are not necessarily acting in concert with their neighbours. So there is no waiting to see who will join the club before knowing how much it will cost everybody. There is no scheduling issue waiting for all the agreements and cheques to come in.

Freehold acquisition can certainly be a stressful process, especially when we get to the final notice serving. In one instance we were calling a flat-owner in Dubai at 5am and personally door-stepping flat-owners. Superhuman levels of persistence and patience (or persuasive salesmanship) can be required to ensure maximum participation in one block. Had we not rounded up all the participants and done the legwork, all the months of effort would have been wasted. Without a virtual full-timer to co-ordinate such a time-sensitive process, I wonder how many DIY freehold acquisitions simply fail to complete because the organisers just don’t have enough time to devote to it.

But back to the cost. In more affluent areas with flat values exceeding £400,000 we find a general strong enthusiasm to acquire freehold, whatever the cost and the issues. But in provincial areas where flat values and earnings are lower, the acquisition of the freehold is not regarded as investment, but more as a cost. Right or wrong, this is their perception. And funding the whole transaction is a greater consideration than the practicalities of completing it.

In residents’ meetings where the options are laid out, we find that blocks of lower-value flats are more likely to baulk at freehold acquisition when we explain that they will need to buy out the non-participants. They are fine with the idea of paying for their share of the freehold or paying to extend their lease but carrying freeloaders was not on their agenda.

Of course this matter of funding is a matter of perception. Mortgage lenders are happy to extend borrowing to fund what they see as an improvement to the value of the asset. And arrangements can be made with a number of banks that can provide commercial funding.

It is not difficult to find investors outside these blocks who are happy to pay for a share of freehold for a flat. And all too often a white knight within the block emerges who is willing to pay for another flat’s share of freehold. These people see this investment like any other. Since the lease is a wasting asset – the value of the flat goes down faster and faster as the lease gets ever shorter – the value of buying into a newly-formed freehold company or cost of extending a shortening lease rises for the non-participating flat.

And eventually the investor is able to realise the value of their investment. Of course, it needs far-sighted investors for one can never be sure when the non-participant will come knocking on the door of the new freehold company asking either to extend the lease or buy into the company.

Freehold acquisition is riddled with emotional impediments to it proceeding. Chicken and egg scenarios abound: “I’ll do it if everybody else does it” is the oft-heard mantra. Usually it is for a practical reason that flat-owners eventually admit defeat and settle for lease extensions. After all, they are still saving money if they act together rather than extending their leases individually. And many simply accept second-rate management as a necessary evil. They address the immediate pain that is the shortening lease and then tolerate the dull ache of the continuing issues relating to the freehold. Even Right to Manage does not offer the solution without volunteer directors.

If you are looking to sort out the issues related to your freehold then be realistic. Freehold acquisition seems like the option offering the greatest freedom. But be prepared to settle for a lease extension if you want a quieter life!

Copyright Leasehold Solutions and Alex Greenslade. Reproduction by permission only