Ground rent (aka land lease) is that rent paid for the land (and not the physical properties or top structures). In other words, it’s rent paid for leasehold control.
There are three ways, in descending order of control, that property can be occupied:
- Freehold – the occupier owns both the land and the property (top structures) built on the land
- Leasehold – here the occupier
- Pays ground rent for the land (i.e. does not own it), but
- Does own the property
- Lease – here the occupier owns no property, and pays a rental for both the land and the property
Ground rent can be paid monthly, quarterly, semi-annually, or annually.
The duration of such an agreement can range from 21 years up to, more commonly, 99 years, 125 years, or even 999 years.
The leaseholder will have to seek permission from the freeholder should they want to make any changes to the property.
In the instance that the ground rent agreement is terminated, the leasehold relationship will fall away. Here ownership of the property or top structure will shift to the owner of the land.
What is peppercorn ground rent?
This term refers to a small or insignificant ground rent. I.e. it is the cost of a peppercorn. While inflation is one cause of this, the source of this is historical and practical. At one stage, peppercorns, like other spices, were a valuable commodity – and thus peppercorns were a method of exchange.
Why have any rental at all? For a lease contract to be considered legally binding, each side must provide ‘consideration’. While the freeholder’s value is the land, the leaseholder must exchange something of value to the other party.
Valuing ground rent / the freehold relationship
How is the freehold interest valued?
Firstly the annual ground rent payable, less the costs of collection, is determined.
Then, a multiplier (similar to the inverse of a cap rate or yield) will be applied to this value. The following factors will influence the multiplier
- Positive: the outstanding term of the lease (longer is better),
- Positive: future scheduled escalations in the level of ground rent (more frequent, higher escalations are good)
- Negative: marketing interest rates (higher costs of financing reduce affordability, and thus the value payable)
- Negative: the probability of tenant default (a weak tenant covenant impairs the quality of those future cash flows)
In addition, the net present value of the built structures will be calculated. I.e., at the end of the lease, the freeholder (to whom the ground rent is paid) can obtain ownership of the property. The shorter the lease the greater the reversion value. Such value is used in determining the “marriage value” – a substantial sum paid by the leaseholder to extend a lease with less than 80 years to run. This compensates the freeholder for not gaining control of the built property (and secures use of the asset for the leaseholder).
