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Hefty rent rises for leaseholders

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  • Hefty rent rises for leaseholders

    Hefty rent rises for leaseholders
    By GREG NINNESS - Sunday Star Times | Sunday, 27 January 2008

    Buyers of leasehold units in some of the country's most prestigious residential developments are likely to face a double whammy as their ground rents come up for review.

    The surge in property prices over the past six years means many owners will be facing ground rent increases of 300 to 400%, and that in turn is likely to cause a sharp fall in their properties' resale values.

    Leasehold residential developments have become an increasingly common feature of the market over the past few years, particularly in Auckland where the property boom has fuelled the redevelopment of large tracts of inner city land. Many new apartments clustered around the historic Central Railway Station building at the bottom of Parnell and spreading back around Viaduct Harbour and also at Beaumont Quarter opposite Victoria Park, are on leasehold titles.

    Typically a leasehold development works like this:

    The developer retains ownership of the land via the freehold title. The units or apartments are built on the land and sold off individually to owner-occupiers or investors on leasehold titles.

    Buyers are purchasing the physical structure of their unit or apartment, but not the ground it sits on.

    The leasehold title gives the unit's owner the right to occupy the underlying land, and the land's (freehold title) owner the right to charge them rent for doing so.

    This is referred to as "ground rent" because it is literally for the ground and not for the building that sits on top of it.

    The lease document which sets out this arrangement would stipulate a formula for determining the ground rent and for adjusting it on a regular basis.

    Ground rent is often set as a percentage of the land's theoretical market value. The percentage can vary widely between developments; in most recent complexes it has been set around 6% or 7%.

    Old style leases on church-owned properties adjusted the ground rents every 21 years, but most modern leasehold developments adjust the ground rents at intervals of between five and eight years.

    The advantage of this arrangement is that it provides the developers with the development margin on the units when they are sold and allows them to capture the rising capital value of the land, paid to them as regular income through the ground rents.

    Leaseholders have a depreciating asset they must maintain, and an ongoing liability to pay rising ground rents.

    Leasehold developments built within the past few years are now starting to face their first ground rent reviews and, on the back of huge rises in residential property prices since they were built, this is leading to some hefty increases.

    For example, it is understood the ground rent on the Latitude 37 complex at Viaduct Harbour is increasing from $160,000 a year to $659,355 a year. This means that on average, each apartment's share of the ground rent would rise from $2000 a year to $8242 a year - a more than fourfold increase.

    While such big ground rent increases will put an immediate dent in owners' back pockets, another consequence is the effect they have on selling prices.

    Put simply, the price someone would pay for an apartment where the ground rent was $15,000 a year is likely to be considerably less than for an identical apartment where the ground rent was $4000 a year.

    Andrew Bond, a sales consultant at apartment specialists City Sales, has considerable sympathy for both vendors and buyers trying to agree on prices of leasehold apartments in the current market.

    While selling prices in some leasehold complexes had fallen by more than 20% over the past year, there were not yet enough sales to pick a trend.

    "I don't know how much prices might fall by," he said. But he believed those most likely to sell would be investors rather than owner-occupiers - a leasehold structure with rising ground rents makes it difficult to make money from a rented apartment, and there is no capital gain to make up the difference.


    Anyone considering a leasehold property should do some careful sums to check whether it is realistically priced.

    * Compare the property with similar ones on freehold titles in the same area. This provides a price benchmark for the leasehold, except that it is being sold without its land. So you must deduct the value of the land from the benchmark figure.

    * Ground rent is usually set as a percentage of land value - eg, if the ground rent is set at 7%, and the rent is currently $15,000 a year, this implies the land is worth $214,285. Adjust this figure for any changes in land value since the ground rent was last adjusted.

    * If the rent was set two years ago and property values in the area have risen 10% since then, increase the land value by that amount. In the example above, this would bring the land value to $235,713. Deduct this from the benchmark figure of similar freehold properties.

    * If these were selling for $550,000, this leaves a residual value of $314,287. Use this figure as a guide to what the leasehold property might be worth.

    * Forget about capital gains. Modern leasehold developments have been structured so that the landowner collects most of the capital gain.

    "There's one way to find out if a man is honest-ask him. If he says 'yes,' you know he is a crook." Groucho Marx