Trophy properties - some considerations for lenders
Finance brief - 1 July 2013
- Announcement of LIBOR changes
- Farewell to the Mandatory Costs Schedule?
- BCOBS: Use of the right set-off
- Can a lender ever rely on a material adverse change event of default?
- A guide to lending against life assurance policies
- Trophy properties - some considerations for lenders
Whilst the process of buying a residential property in a "prime" UK location is much the same as buying any other residential property, there will often be factors affecting high value residential properties (referred to as trophy properties) that need particular consideration. We have explored some of these briefly in this article and set out a summary of some of the key issues and other factors that may be of interest to a lender whose client is considering acquiring a trophy property.
If your client is buying a house, it will usually be bought with an absolute freehold title which has been registered at the Land Registry. This is the highest and most valuable class of title available and gives the buyer complete ownership of the land and all the buildings on it.
With a freehold title the legal owner has the right to occupy and deal with the property as it chooses subject only to any covenants that may be on the title or planning laws and building regulations imposed by the local authority and government.
Furthermore, a title which has been registered at the Land Registry is in effect guaranteed by the state. Anyone who suffers loss because of an error or omission in the register, or because the register needs to be corrected, will normally have the benefit of an indemnity.
If your client is buying a flat, it will usually be bought with a leasehold title. This is where the property is held under a lease. The leaseholder is granted the right to occupy the property (land or buildings, house or flat) for a set period of time ("term") by the freeholder. At the end (or earlier termination) of the term the property returns to the full possession of the freeholder. Leases can be granted for terms from a few months to 999 years, depending on the circumstances of their creation. Most leasehold flats have leases of between 99 and 125 years when first granted but the remaining term may be considerably less than this at the time the flat is re-sold by the current owner.
Freehold flats are rare but do exist and are very problematic legally (particularly when looking at overall building maintenance responsibility). They are generally not accepted as security for mortgage finance and, consequentially, can prove difficult to sell.
There are numerous factors for your clients to consider when purchasing a leasehold property and we briefly discuss some of the key factors below:
- Remaining lease term - If there are less than 80 years of the lease to run it may be difficult to obtain mortgage finance for the purchase of the property. Leaseholders (subject to certain qualifying criteria) do have the right to extend their leases. It is therefore important for owners of such flats to exercise their rights to extend, especially if they are thinking of selling at a later date. The lease extension and lease enfranchisement process is complicated and will require specialist legal advice. Leaseholders of residential blocks (again subject to certain qualifying criteria) also have the collective right to buy-out the superior freehold interest (a process known as "enfranchisement"). This however will require a level of co-operation and co-ordination amongst the "qualifying" leaseholders and may require the underlying leases to be amended so as to ensure, amongst other things, that any "share" in the freehold acquired is transferred to subsequent purchasers.
- Alterations – Owners of leasehold flats will only be able to carry out works to the extent permitted by the lease. Internal decoration and minor alterations are normally not an issue but if your client is considering making structural alterations (e.g. knocking through walls to create an open plan living space, or even putting in wooden floors) these may either be restricted altogether or only permitted with the Landlord's consent. It is quite common for purchasers of flats in prime locations to want to carry out complete refurbishments following acquisition. It is very important therefore that the lease is carefully reviewed in advance in order to verify that the intended works can be carried out and to ascertain any conditions that may apply to the carrying out of such works.
- Sub-letting – Whilst an absolute restriction on sub-letting can affect valuation, it is not that uncommon for leases of flats in older style blocks in prime locations to contain such a restriction. This can be an unwelcome surprise for a "buy to let" purchaser who has not carefully checked the provisions of the lease. The main reason put forward by landlords for prohibiting sub-letting is that other leaseholders in the block may be prejudiced if there is no such restriction as if most of the flats are occupied by people who do not own their property they will not care as much about the standard of the building and as a result the value of the flats in the building could diminish. Leases should also be checked for conditions and restrictions that may apply on sale/assignment and whether the landlord's formal consent is required (and, if it is, that it cannot be unreasonably withheld).
- Service charges – When purchasing a leasehold flat it is important that your client looks into the level of current and future service charges and what works might be included. For apartment blocks in prime locations, service charge levels can be extremely high and it is recommended that the service charge accounts for the preceding two or three years are reviewed and that details of any large items of service charge expenditure planned for the future (e.g, new lifts, new roof, heating and air conditioning plant) are obtained from the seller's solicitors.
Planning Permission and Building Controls
It is fairly common for buyers of houses in prime locations to seek to demolish the existing property and build a new bespoke home or to substantially extend and re-model the house that has been purchased. Such works will require planning permission from the local authority and must also comply with building regulations.
To apply for planning permission, your client will have to send a planning application (and fee) to its local authority. The planning application will be considered against local planning policies and any objections received from the public. Your client should take professional advice to help prepare plans that are likely to be acceptable and to negotiate the planning process.
Planning approval may be granted outright, conditions may be applied or a planning application may be rejected. Your client can negotiate minor objections, submit a new application taking into account concerns raised by the local authority or appeal a decision that goes against it.
Internal alterations do not normally require planning consent, though there are more stringent rules for "listed buildings" and in buildings in conservation areas. Listed buildings are those which are of special historical or architectural importance.
Carrying out a building project without planning permission can be disastrous. Although your client may be able to apply for retrospective planning approval, this may be refused and your client may face a requirement to demolish unapproved premises or cease activities that are not permitted.
Under the building regulations, building consent for major building works is normally required: for example, for new construction, significant extensions or structural alterations. Changing the use of premises can also require building control approval: for example, to ensure that the building meets relevant fire safety standards. The local authority can approve, reject or impose conditions on the project.
As with planning permission, going ahead without building regulation approval can be very risky. Your client could face an order to demolish unsafe alterations or experience problems when trying to sell the premises.
There have been several high-profile stories in the press recently (a number involving basement excavation proposals) where buyers have tried and failed to make extensive changes to their properties and found themselves falling foul of planning regulations and unable to implement their hoped for structural changes. Your clients should accordingly discuss their development plans in good time with their legal and other professional advisers in order to avoid the many pitfalls in this area.
There is little tax-incentive for a UK resident and domiciled individual to purchase a dwelling other than in his individual capacity. This is particularly the case where the individual intends to occupy the dwelling as his only or main residence, in which case any gain arising from the future sale of the dwelling will be exempt from capital gains tax ("CGT"). In contrast, this exemption is not available if the dwelling is owned by a company. Furthermore, the occupation of a dwelling by a UK resident can give rise to very expensive income tax charges on a deemed benefit in kind where the dwelling is owned by a company.
In contrast, for a non-UK resident and domiciled individual, the benefits of having the dwelling owned by an offshore company (or unit trust) have been overwhelming. In particular:
- It is the company's name that was recorded on the Land Register, providing anonymity for the individual.
- The company is outside the scope of CGT.
- The shares in the company would be treated as non-UK situs and so outside of the individual's estate for inheritance tax ("IHT").
- A sale of the dwelling could be structured as a sale of the shares in the company, with no liability to stamp duty land tax ("SDLT").
In 2011, The Times newspaper began a campaign to draw attention to what it perceived as the unfair tax advantages enjoyed by individuals who were able to structure the purchase of high-value dwellings through offshore companies. The campaign focussed almost exclusively on the SDLT advantage. In reality, very few purchases of dwellings were structured as the purchase of shares in a company, due to the difficulty in protecting a purchaser from inherent liabilities of the company. Nevertheless, the campaign resulted in legislation which severely reduced the attractiveness of holding high-value dwellings in this way.
The new rules apply to a dwelling worth over £2 million, owned by a corporate body which for these purposes means a company, unit trust or partnership with a corporate member. Where they apply (in summary):
- The purchase of the dwelling is subject to SDLT at a rate of 15% (instead of 7% which applies to purchase by an individual).
- Any future sale of the dwelling by the corporate body is subject to CGT on gains accrued since 6 April 2013 at a rate of 28%.
- With effect from 1 April 2013, the corporate body is subject to an annual tax, known as Annual Tax on Enveloped Dwellings ("ATED"). The amount of ATED is based on the value of the dwelling as at April 2012 and is charged at the following rates:
Property Value ATED
More than £2m to £5m
£15,000 More than £5m to £10m
More than £10m to £20m
More than £20m
- The IHT treatment referred to above is unchanged.
- The ability to structure a sale of the dwelling as a sale of the shares with no liability to SDLT is unchanged.
As a result of the changes, it is no longer automatically the case that a non-UK resident and domiciled client should arrange for a high-value dwelling to be owned by an offshore company. Instead, a determination needs to be made as to whether the advantages of anonymity and freedom from IHT given by such a structure outweigh the new tax charges. In many cases, it may be preferable to forego these advantages. If anonymity is the principal concern, legal title to the dwelling can be held by the company as nominee for the individual - this will preserve anonymity while giving the same tax consequences as if the individual directly owned the dwelling.
In certain cases, it might be possible to implement a structure to preserve the tax benefits of holding a dwelling through an offshore company while mitigating the effects of ATED and the new charge to CGT. Clients will need to obtain advice on whether such a structure is possible in their particular circumstances.
There are certain exemptions from the new regime, the most important of which apply to property developers and dwellings let on a commercial basis to unconnected tenants - in such cases the purchase and holding of a dwelling through an offshore company will continue to be attractive.
Specific considerations in lending to individuals to finance the trophy property
When lending to an individual to finance the acquisition of a trophy property (or seeking to obtain a personal guarantee or security from an individual who is acquiring a trophy property), a lender will need to consider a number of additional specific matters. Amongst the relevant considerations are the application of (and any relevant exemptions from) the Consumer Credit Act 1974 (as amended) (the "CCA"). Specific advice will be required on any given transaction, but in particular, in the context of the acquisition of a trophy property it may be the case that the "high net worth individual" exemption may apply. This exemption may apply if the borrower is a natural person with an income (net of National Insurance contributions and income tax) of not less than £150,000 and/or net assets (excluding items such as the value of their primary residence and pensions contributions) of not less than £500,000 in the previous financial year. It is an additional requirement under the CCA that the credit must either exceed £60,260 (if it is not secured on land) or be secured on land in order for this exemption to apply. It should be noted that there are additional requirements for the documentation and certification of status in order for this exemption to be available. In addition, the lender should consider whether the mortgage is a Regulated Mortgage Contract (which is exempt from the CCA). A Regulated Mortgage Contract is a loan to an individual borrower (or trustee), secured by a first charge over land/property in the UK, at least 40% of which is to be used as or in connection with a dwelling by the borrower, a beneficiary of a trust or a member of the borrower's immediate family. Please see our previous briefing paper on Lending to Individuals for a detailed summary of relevant considerations.