“Why did no one senior at the company say, ‘This will come back to haunt us’?”
By Don Quijones, Spain, UK, & Mexico, editor at WOLF STREET.
Fallout from he UK’s ground rents scandal, which we reported on a week ago, is beginning to take a financial toll on some of the companies most implicated in it. That includes the country’s third largest home builder, Taylor Wimpey, which took a 24% hit to first-half profits after setting aside £130 million ($170 million) to help home buyers affected by the leasehold scandal. The government is investigating. Depending on how new legislation and pending lawsuits pan out, the company could end up owing a whole lot more.
Leaseholds have been around in the UK for centuries and are commonly used for apartment buildings, where there’s some semblance of shared land and building use. When a house is purchased as a leasehold, the buyer, knowingly or not, is really no more than a tenant, albeit one with a tenancy agreement that can last up to a century or more. The freehold — the building as well as the land the property occupies — belongs to somebody else, usually the builder that sold the property, or an investment firm.
This archaic arrangement didn’t used to be much of a problem as the annual payments leaseholders had to make to the freeholder were tiny. Sometimes they weren’t even worth collecting. But in recent years, the terms of the leases have become increasingly onerous, with higher initial rents that can then double every 10 to 20 years over the duration of the lease.
Taylor & Wimpey was one of the biggest offenders, though it quickly sold many of its freeholds to third-party investors attracted by the rising income they provide. Another popular draw of today’s generation of freehold agreements are the iron-clad guarantees they provide investors, as London-based real estate firms Savills pointed out in a 2012 report:
Because the ground rent is usually a nominal sum, the leaseholder is incentivised to pay under the threat of losing their property if they fail to do so and therefore the risk of default is minimal… In the event of a leaseholder default, the leaseholder’s mortgagee (i.e. the bank) will typically pay to avoid forfeiting their security and should there be further default, the freeholder has the right to forfeit the lease and gain vacant possession of the property. Default is therefore extremely rare.
For years Taylor Wimpey brushed aside public concern and criticism about its practices, even as soaring ground fees trapped its customers in homes they couldn’t sell or renovate without shelling out thousands of pounds in usurious fees to a faceless management company. Many of these customers complain they were never told by the company or the lawyers it kindly recommended to them that the ground rents would double every ten years.
Now that the UK government has pledged to outlaw leaseholds on new-build houses while drastically restricting ground rents for apartments to a “peppercorn” value, the company has finally decided to make up for some of the damage it has caused — presumably not out of moral imperative but rather from the belated realization that screwing over a large portion of one’s customer base in a very public way does not make for a sustainable long-term business model.
This is especially the case, given that 45% of Taylor Wimpey’s business depends on tax funds through the government’s lavish Help to Buy Scheme, by which taxpayers help
developers sell new-build homes to first-time buyers first-timers buy new-build homes.
The question now is why it took so long for the company to act. More to the point, as the consumer group Leasehold Knowledge Partnership posits, “How on earth did the selling of homes with exponentially rising ground rents seem like a good idea? Why did no one senior at the company say, ‘This will come back to haunt us’?”
The short answer can be summed up in four words: greed, impunity and opportunity. As the land economist Stephen Hill writes in The Guardian, the ground rents scandal exemplifies how normal it has become for many of today’s global businesses and investors to expect to “earn” totally exploitative rewards, without risk or commensurate investment:
This is just more evidence of the damaging commodification of land, and how, since financial deregulation, global capital flows graze effortlessly on our local housing markets for the risk-free excess profits they so willingly give up.
The result in the UK is that many of the young families that were given a leg-up to the first rung of the property ladder by very generous public subsidies are now stranded there with little or no hope of reaching the second rung.
For the builders and developers that made huge profits off this scheme, the blowback may have only just begun. As the investment firm Shore Capital warns, if there is broader, substantial reform of leaseholds, not only would a stream of profit for the households be eliminated going forward, there could be potentially high costs for restitution or compensation related to historic home sales:
In the round, this could become a material drag on sector profits and free cash generation. We believe all house builders are under a substantial but largely unacknowledged threat here and this adds another risk to investment in the sector.
Investors already appear to have taken heed, with the result that the three biggest sliders on the FTSE 100 on Friday were the giant home builders Barratt (-4.3%), Persimmon (-3.8%) and Taylor Wimpey (-3.5%). By Don Quijones.
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