COMMENT For many years, Strettons has been selling freehold residential ground rent investments at auction, writes Ian Mann.
Our upcoming February sale features a portfolio of 63 ground rents – the most we have ever sold in a single auction – with an anticipated total realisation of circa £700,000, and price per lot ranging from a £1,000 to several thousand pounds.
The portfolio is made up of purpose-built blocks of two to four flats, or pairs of maisonettes, within a fairly defined east London area. We anticipate a mixed bag of buyers – long lessees, experienced and inexperienced investors who fancy starting or adding to a property portfolio at a relatively low entry level.
Over the last five to 10 years we have seen interest in ground rents rise, with some surprising prices being achieved at auction.
This could be because ground rents are often a misunderstood investment option, and these are less informed buyers paying over the odds, but we see it is as more a function of investors looking to widen their portfolio and being able to buy half a dozen or so ground rent investments, compared with what is now perhaps a less attractive single buy-to-let lot.
Interestingly, until the late 1990s few investors dabbled in ground rent investments. However, as a tranche of leases started to creep toward less than 80 years unexpired – the “trigger date” for lease extension premiums to rise – it dawned on more investors that this provided an opportunity to increase returns and extract a higher income from their investment.
More recently there has been a trend of unlikely buyers, mostly in the guise of large pension funds, looking to invest in large, modern blocks that will give them a (very) long term, low risk return. However, with a few exceptions, current pension fund law prohibits self-invested pension funds holding any form of residential, including ground rents, in their portfolio.
There are now effectively two ground markets – one for the large modern blocks, and one for residential ground rents, where the units are in smaller purpose-built blocks or converted houses, or where purpose-built pairs of maisonettes have been sold on long leases on ground rents.
Those who invested a couple of years ago have discovered that their ground rents have turned out to be a nice little earner, particularly where tenants have sought to extend their leases or buy the freehold. So it is important to understand the ins and outs of buying and selling freehold ground rents. I am sure many auctioneers have a story about a buyer purchasing a ground rent, only to then ask for the keys!
What can be considered a “good” ground rent investment depends on several factors, the most obvious being the number of flats within the freehold, but also the length of lease on each unit, the ground rent income and the rent review pattern.
Also, to some buyers, it is important to know whether the freeholder can insure and earn commission from it and recover the premiums from the lessees, and whether he can charge for managing the property, as well as whether there is the potential for development in the grounds or at roof or attic level.
Would-be buyers should also enquire as to whether the lessees have reserved their rights in accordance with the section 5 notices served by the landlord, or whether a right-to-manage company has been formed by the lessees, allowing them to take over the management and insurance, as these factors will adversely impact on the level of bids.
The market currently seems strongest for investments where the unexpired lease terms are below 80 years.
There is generally a correlation between the bid price and the unexpired lease term, as the freeholder is anticipating that individual leaseholders will approach him for a lease extension because most mortgage lenders considering a loan like to see at least 80 years on a lease.
For leases above 80 years, unexpired sale prices are usually anything between 15-35 times the rent, or an initial gross return of a little under 3% rising to 6.6%.
Some examples can be seen in the table above, where the prices comfortably exceeded the guide. Assuming these bidders are experienced enough to know what they are doing, they wouldn’t be buying if they weren’t confident of getting a better return on their investment.
Much like with oysters – now enjoyed by the wealthy but considered a pauper’s meal in Victorian times, when residential developers began granting long leases – if you do your homework, ground rents might offer a pearl in your portfolio.
Ian Mann is associate director at Strettons
