Freeholds can be fun

Ground rents equal regular income - plus the chance of a large payout. Chris Partridge reports

On the surface, freehold ground rents don't seem tremendously fascinating - the footnotes in the auction catalogue, lists of addresses, figures that nobody reads... But buying the freeholds of properties, even though the actual property may belong to the leaseholder for up to 999 years, can reap worthwhile returns. And there is always the exciting possibility, however remote, that the leaseholder will fail to pay the rent and the property falls into your lap.

On the surface, freehold ground rents don't seem tremendously fascinating - the footnotes in the auction catalogue, lists of addresses, figures that nobody reads... But buying the freeholds of properties, even though the actual property may belong to the leaseholder for up to 999 years, can reap worthwhile returns. And there is always the exciting possibility, however remote, that the leaseholder will fail to pay the rent and the property falls into your lap.

Ground rents are also cheap, ranging from about £3,000 for the freehold of a house in the provinces to many thousands for a block of flats in central London.

Freehold ground rents come in three categories, according to auctioneer Gary Murphy, of Allsop & Co, who regularly puts them under the hammer. The first category is simple, and is actually as unappealing as you might think. The leaseholder has complete control of the property for the term of the lease, subject to rent reviews every quarter-century or so. "This type of lease is not usually sought after," Murphy says.

The second type of lease puts the responsibility for insuring the property on the freeholder. "This is the investors' favourite," Murphy says. "This allows the investor to arrange the building's insurance with the company of his choice and get a commission."

Somewhat shockingly, the law even says that landlords do not even have to shop around for the best deal unless the lease specifically obliges them to do so. So all they have to do is shop around for the best commission. No wonder investors love it. The third option, Murphy explains, is leases that allow the landlord to nominate the insurance company but obliges the tenants to buy the policy. "This can be problematic because the lessees have the right to challenge the choice."

Insurance is not the only way of making money out of freehold ground rents. Many properties, particularly blocks of flats, have unregarded nooks and corners that can be exploited or developed. "Sometimes there is garden land, derelict garages or flat roofs which can be developed," says Murphy. "Often there is a small porter's flat but no obligation to keep a resident porter, so you can employ someone who lives out and sell the flat."

Roofs have proved a rewarding investment for some freeholders. Modern technology enables the construction of one or two extra floors, in the form of penthouses that can be sold at substantial prices. Leasing the roof and "air rights" above a block to a specialist developer can benefit everyone, because the developer will want to spruce up the common parts and perhaps even repaint the exterior of the block.

Many investors are motivated by a desire to give their descendants a bonus, according to Murphy. "I do have investors whose families bought freehold ground rents decades ago and are now reaping the benefit as the leases fall in," he says.

Chris Coleman-Smith, auctioneer at Savills, has seen an upswing in interest in ground rents recently, largely fuelled by huge increases in capital value, however theoretical that value might be. "If you bought ground rents 10 years ago, you would be sitting on a gold mine," he says. Most investors buy ground rents as a very long-term flutter. "You buy 80-year leases and in 10 years' time things happen," he says. "As the lease gets shorter and starts to have an effect on the value of the lease, you can sell leasehold extensions to the tenant."

Building up a big portfolio is the way to make money out of ground rents. Coleman-Smith says: "The more you have, the cheaper they are to run. Some people have hundreds of them, with computerised systems for sending out rent reminders and so on." Even if you are buying for the long term, it is always worth checking the property in detail when you have bought it. "I have seen several properties where tenants have expanded into unused roof spaces without getting the landlord's consent," he says. "They will usually pay to be given retrospective permission."

Like premium bonds, bulk buying brings in a regular income, with the added spice of the chance of a big win. "I knew a bloke who found the ground rent had not been paid and ended up getting the whole flat," says Coleman-Smith.