The Joys of Leasehold


Ah, the joys of not owning your land.  The battles of land owners with considerably surprised tenants are an unfortunate source of income for both valuer and lawyers and, generally, for the landlord.

Not so much for the tenant, caught paying both ground rent and body corporate fees and having to stump up the costs of lawyers, valuers and arbitrators, often without having a business structure to deduct those costs against or claim GST.

On the other side of the coin, ground rents have also historically been used as a method of permanently (for all practical purposes) parting Maori from their land, with the tenths trust, that was supposed to hold ten percent of all land held for Maori, leasing the land on perpetually renewable leases to farmers at rent reviewed only every 21 years, yielding an utter pittance to Maori and leaving them locked off their own land in seeming perpetuity.  The Public Bodies Leases Act (and predecessors) also acted to keep rents low, in a way that does not apply to private landlords.

About 5-10 ten years ago, however, even Taranaki farmers were beginning to complain that ground rent was becoming unsustainable, farm prices having risen so much.  The next round of reviews, assuming food prices (and therefore, one expects, the land prices) continue to increase around the world, will be a very painful affair.

Generally speaking, the best thing the public can do is avoid leasehold property.  Only if you have the nous, expertise, and negotiating skills to acquire the property for a price that takes future rent increases into account should you venture there, if you absolutely must.  The problem is that future rent crystal-ball gazing is an activity fraught with danger.

An article on the weekend in the Sunday Star Times caught the eye regarding apartments in and around the old Railway Station.  Readers may recall that this land was given (or returned, as your point of view may be) to Ngati Whatua o Orakei as part of a treaty settlement.  Ngati Whatua opened it up for development by, in part, agreeing to lease the land rent free for fifteen years.

Good for the tenants, right?  Well, not really.  The developers would promptly have priced the rent free period into their proposals and selling prices.  Perhaps a skerrick (my word of the week) slipped through to the punters.

Anyone buying should have done so with a view to the rent free period ending, and perhaps the present fears are overblown.  Past history is not kind, however, with the drawn out struggles over the Beaumont Quarter an example.  Most of the land down the Viaduct Harbour is likewise leasehold, and on the first review seven years down the track the rent per apartment often quadrupled from, say, $2k per annum to $8k.  $40/week is a small price to pay for a presumably cheapish apartment.  $160/week is a significant challenge.

Usually the only way to challenge the rent paid is to challenge the landlord’s valuation and methodology and, if no result is obtained from negotiation, drag the process into arbitration….generally not much cheaper than court action, as Beaumont Quarter residents found out.

Faced with such unexpectedly high ground rent increases the Residents Society commissioned a report on its legal options by law firm Glaister Ennor.

The report said the lease allowed the owners to challenge the valuations used to set the ground rents but warned that the legal costs involved could run to between $300,000 and $500,000, which would have to be passed on to apartment owners.

No word on what it actually cost them in the end, but they did get the rent reduced from $4.4 million to $3.1 million, which I suppose makes even $500k in costs a small price to pay.  Still more than the $2.2M the tenants had considered the rent ought to be.

It is struggles like this that the Quay Park residents are rightly afraid of.  It is difficult to be critical of Ngati Whatua, who have had no return for the past fifteen years in a commendably long-sighted approach.  If the article is to be believed, they are also being generously pragmatic:

In most cases, each building’s annual ground rent will be set at around 6% of the value of the land it occupies. A valuation report commissioned in 2009 by the body corporate of one affected apartment building suggested this could result in average ground rent payments of $9000 a year per apartment.

Under the terms of the leases, building owners could dispute the valuation used by Ngati Whatua and try to negotiate a lower figure. If that is unsuccessful, the dispute could go to arbitration.

However, ground rent might not be as steep as many owners fear. Informed property sources say behind-the-scenes discussions between Ngati Whatua and some leasehold property owners suggest apartment owners may only have to pay $4000 to $5000 a year.

It would be in keeping with the long term views of Ngati Whatua, who are much less shareholder (and not at all mortgagee) driven than commercial entities, to be more relaxed on the ground rent.  Obviously the amount of ground rent income determines what the land is worth as an asset…both the underlying freehold, and the value of the leasehold units.

This is why other ground-leasing landlords in Auckland have a big stake in all of this, because valuers tend to take the revenue from neighbouring and/or similar properties into account.  If Ngati Whatua settle for much less in percentage terms than, say, Beaumont Quarter, then ground renting landlords will be taking a valuation hit, and the owners of leasehold units will not see as much disappear off the realisable value of their apartment or commercial premises.  It is unclear whether valuers would make any allowance for perceived Ngati Whatua “generosity”.

Elsewhere in Auckland, “old style” residential leasehold has generally been on 21 year leases.  These are actually pretty good for the tenants, who sit there paying rent ten or twenty years out of date, but when the 21 years is up there is nothing surer than someone who has been paying a pittance will complain bitterly about the injustice of actually having to front up with what the land is worth, as this example from 2005 shows.

Taking the longer view, they could consider that the burden will soon fade back into insignificance again, but then again that does nothing for pain right then and there.  It does seem that residential property land values have increased to the point that ground rental can be just a tad too much to be afforded….either that, or people simply haven’t properly factored in the upcoming rental when they decided to buy.

As an interested lay-person in the science of investing and valuation, it seems to us that the cost of the underlying land, and the risk of future rent increases, are simply not well considered by the majority of purchasers who would have been well advised to buy freehold only….a proposition far easier to understand.

We have also seen relatively modern breeds of ground lease document that review the rent every year using the worst of all possible worlds for the tenant.  For example, a ground lease that either raises the rent to “market value” OR raises the rent by the movement in the CPI (this year 4.5%), whichever is better for the landlord, and provides that the rent can never go down.  This is more common in commercial leases that come to an end in as little as two or three years, and is completely innappropriate for a one hundred to one thousand year ground lease.  Needless to say, our advice was to walk away from the purchase.

Unfortunately this type of provision is all buried away in the fine print that many purchasers will never fully read nor appreciate….and it may be a tricky task to extricate them if they haven’t had professional advice before signing an unconditional contract or one with very limited conditions.

Only when the next rent review comes around do they truly recognise what they have gotten themselves into…

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About Ivan McIntosh

I am a partner of Carter Atmore Law...residing in City Road just off the busy thoroughfare of Symonds Street, Auckland, New Zealand....where we are specialist business & property development lawyers, working for both local and international clients. Proud husband to Joanna, and dad to two sons. Passionate rugby supporter. Email: imcintosh@calaw.co.nz Ph: 64 9 921 5026
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3 Responses to The Joys of Leasehold

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  3. Pingback: Ngati Whatua Ground Rent Armageddon draws closer | The Pitt Street Lawyer

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