Choosing between freehold and leasehold properties has always been a concern for international investors who look to invest in the UK. leasehold properties seem to be a popular choice for many investors, but is it a better investment than freehold houses? Let’s dive into the main differences between leasehold and freehold, and uncover everything you need to know about these forms of ownership.
Period of ownership
The biggest difference between these two types of property ownership can be concluded in one sentence – owning the property outright or owning the property for a specific period and having a landlord. When you purchase a freehold property, you own the building and the lands it stands on outright, including the ground below and airspace above. Purchase of a freehold means you become a freeholder that has the right to renovate or refurbish the entire property to fit better with your needs.
On the other hand, if you buy a leasehold property, you only have the right to live in or use the property for a particular period of time, equal to the number of years left of the lease. Depending on the type of property, the period of a lease agreement can vary from 10 to 999 years. The lease can be extended relatively cost-effectively as long as there are at least 80 or so years remaining on the lease. Although leaseholders have to pay for the lease, the ownership of the property and land it stands on will revert back to the freeholder at the end of the lease, unless the lease is extended or is bought from the freeholder.
Alterations to the property
With freehold properties, you will have to take the responsibility of maintaining the property, from daily maintenance to significant upgrades such as replacing roof tiles. From an investment perspective, this responsibility can be a burden, particularly if you are not in the UK and don’t have a local network of plumbers, electricians, and handymen. Hence many investors use services the services of property managers to assist in the property’s upkeep, but this means your financial return on your investment will need to account for the added cost of these services. Apart from the hassle of looking after the property, freehold has always been seen as an attractive investment choice for many investors, as investors have the right to make refurbishments, construct a house extension or, even rebuild the property without requiring the consent of the freeholder. Note that much of this type of work would still require permission from the local council before it can proceed! Renovations can add value to properties and a popular way of generating capital returns prior to the sale of a property. As a result, the demand for freeholds remains high.
In comparison, leasehold properties are often more restricted since leaseholders have to get permission from the freeholder to make certain significant changes or alterations to the property. The strictness on a property depends on the landlord: private landlords are usually more flexible and less restrictive than property development groups. On the other hand, freehold properties allow more flexibility for leaseholders in other ways. Investors purchasing a leasehold property will not have a direct responsibility to look after the maintenance of the property’s common areas. Nonetheless, leaseholders are still required to pay a ‘service charge’ to cover the cost of ongoing maintenance borne by the freeholder, as well as a small ground rent annually. In recent years, more than 26% of leaseholders have felt that their freeholder is overcharging for the service charge, as the freeholder is not legally bound or even incentivised to search for the most cost-effective solutions to maintenance issues.
Leasehold versus Freehold: which one is right for you?
Every property is unique, as is every investor. In each case, there are several factors to consider, when deciding whether to invest in a leasehold or a freehold property:
Length of Lease: The shorter the lease, the less it is worth! A lease with zero years left is worthless, as the property will imminently revert back to the freeholder, and the lease extension will cost as much as buying a new property. As a general rule, the longer left on your lease the better. In fact, if more than 100 years are left of the lease, then the value of the property is very similar to the value of an identical Freehold property.
Location of the property and rental yields: You should take into account the location and expected return of the property when making an investment decision. Freehold seems to be a better option for many investors, however, not for all cases. A leasehold flat in Central London with a short lease may generate much more revenue than investing in a similar size freehold property outside of London. Leaseholds are extremely common in new-build developments, which in turn are very popular in investment hotspots such as cities and university towns. This often means that properties that are likely to have stable demand from tenants, lower void rates, and strong net yields. This can make for an attractive business case to invest in leasehold properties. On the other hand, freeholds are very common amongst traditional houses in suburban areas which may be popular for families, but may take a longer time to find a replacement tenant for.
Budget: Apart from the property itself, setting your investment budget is also essential. If you are on a tight budget and still want a strong capital return, leasehold may be more suitable for you. Many investors invest in undervalued short lease properties and extend the lease to gain a quick return. This is undoubtedly a risky strategy, as the market for properties with a low number of years remaining on the lease is relatively illiquid.
Transaction length and costs: Another point which is often ignored by many investors is that during the purchasing process, the legal fees for conveyancing leasehold properties generally cost more than for freehold properties, as more work needs to be done. In addition to the higher cost, the conveyancing process often takes a longer time, With the average transaction time for leasehold properties taking around 12 weeks.
Regulation changes: New rules to reduce the downsides of leaseholding are currently being debated by the UK government, to create a newer ‘commonhold’ ownership. Under the proposed rules, commonhold would give owners the freehold ownership of their own property, eliminate the risk of the ownership reverting to the freeholder at the end of the lease, and enable self-management by the owners.
Ultimately, there is no superior investment option between a freehold and leasehold property, and the different characteristics of these two forms of ownership make them fit for different purposes and needs. Only you can decide which is best suited to you!
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