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"Flat purchasers might perceive a conflict of interest where the freeholder and managing agent are the same" Darren Pither is a director of Gray's Inn Estates

Facts for freehold fanciers

If housebuilders keep in mind legislative, technological and market trends, they can maximise their profits when they sell the freehold reversion to an investor, writes Darren Pither

Housebuilders, striving to hit PPG3 targets for brownfield developments, are finding that apartment schemes are often the most profitable strategy. They offer an attractive income through the efficient disposal of the freehold reversion to an investor.

Historically, many developers considered the freehold reversion an administrative burden. Prior to the advent of modern IT systems, they were right. Pursuing an ever-changing list of leaseholders for small rents every six months was a tedious task. Many developers simply gave away the reversion to a managing agent or resident management company or sold the interest to an investor for a token consideration. But the IT revolution meant that rent collection became faster, easier and profitable.

Leasehold power

These days, the major housebuilders have a surprisingly diverse approach to disposal. One residential developer's recent policy has been to sell the freehold to the managing agent instructed on that particular scheme. This has been common practice for some housebuilders for many years. However, given legislative trends that shift power from freeholder to leaseholders, flat purchasers might perceive a conflict of interest where the freeholder and managing agent are one and the same.

The terms of the lease are key to the value of the freehold reversion. In the past, investors have paid a premium for freeholds where the lease vests the management of the building with the landlord. Considering the pending "right to manage" section of the Commonhold and Leasehold Reform Act 2002, it is arguable that such a covenant will be devalued because the landlord will be at risk of losing the management without being at fault. Developers should consider their target market for each scheme and convey the management accordingly.

Pre-empting "right to manage"

With "right to manage" soon to be a reality, some developers may consider pre-empting it by conveying the management to their purchasers by way of a resident management company. However, for schemes aimed at investors or the higher socio-economic groups, the management of the block may be better left in the hands of the landlord, who will then appoint an independent managing agent. This is preferable to having an agent written into the lease because the landlord has the flexibility to change the agent easily if the leaseholders require it.

The covenant to insure the building is always popular with investors. The insurance provision has been open to abuse by rogue landlords in the past. However, the new laws will compel landlords to insure at competitive market rates. Otherwise they could lose that covenant.

Investors also look for clauses that generate fees when administering ongoing matters at the block. For example, there is a reasonable case for requiring tenants to enter into a deed of covenant prior to subletting. The landlord can charge a reasonable fee for this, and the owner-occupiers at a development benefit from the fact that prospective tenants are vetted and absent flat owners tracked.

The earlier the housebuilder discusses a new scheme with the investor, the easier it is to enhance the value of the reversion. It is a quick and simple procedure. As the relationship between the developer and investor grows, the faster and more profitable these deals become.

Reprinted from 9 August 2003 Estates Gazette