To auction freehold ground rents, you’ll need to meticulously follow a number of rules and procedures. These are set out in Section 5B of the Landlord and Tenant Act 1987, which relates specifically to the disposal of freehold ground rents at auction. Essentially, Section 5B dictates that freehold sellers must offer the Right of First Refusal to qualifying tenants before placing the freehold in an auction.
What is the Right of First Refusal?
The Right of First Refusal provides leaseholders (tenants) with an opportunity to purchase the freehold of their building. However, both the property and the leaseholders must meet strict qualification criteria. If the conditions are not met, the Right of First Refusal does not need to be offered. In which case, the freeholder can proceed with the sale at auction or otherwise without consulting the leaseholders.
What are the qualification criteria for the Right of First Refusal?
The property
- Must contain at least two flats
- More than 50% of the flats must be owned by qualifying tenants
- No more than 50% of the building must be in non-residential use
The leaseholder (tenant)
- Must have a lease term of at least 21 years
- Must not own three or more flats
- Must not have a short-hold or assured tenancy
- May have a fixed and periodic tenancy, in most cases
Learn more here: Infographic – Do you qualify for the Right of First Refusal?
If the qualification criteria above are met, leaseholders must be offered the Right of First Refusal by service of a formal Section 5B Notice. Acceptance of the offer will result in the leaseholders (who must elect a nominated purchaser) getting first dibs on purchasing the freehold interest before another party. In the event of a public auction, this “other party” would be the highest bidder on the day.
Do you still need to go to an auction if leaseholders accept the Right of First Refusal?
Yes. That’s a big, legal yes! Here’s why:
Firstly, and most crucially, if you wish to continue with the sale you are legally bound to dispose of the freehold by public auction. This is because Section 5 of the Landlord and Tenant Act 1987, specifies that a disposal cannot be made under different terms to what is stated in the Section 5 Offer Notice. So, whether the leaseholders accept the Section 5B Right of First Refusal offer or not, the sale must proceed at public auction.
Of course, if a freeholder wishes to withdraw from the sale by auction they can do so at any time before the contract is binding. However, this does not mean that the freehold is now exempt from the Section 5B Notice procedure. In fact, the freehold cannot be offered for sale under different terms within 12 months of the date of the original Section 5B Offer Notice. So, if you decide that you’d like to sell privately, for example, you’ll need to serve new notices under Section 5A.
Similarly, if the freehold ground rents do not sell at auction, then the interest cannot be sold, by auction or otherwise without starting the Right of First Refusal procedure again, with a new Section 5B or Section 5A Notice. Breach of these legal obligations is a criminal offence which can result in a conviction and a hefty fine.
But adhering to the terms of the notice isn’t the only reason that you’ll still need to go to auction. When leaseholders accept the Right of First Refusal under Section 5B, they do so without knowing the purchase price. This is because the price will be set by the highest bidder on the day of the auction, and leaseholders will have the right to acquire the freehold at this price. Of course, there will be a reserve price for the freehold interest, but this does not need to be disclosed to the leaseholders.
Lastly, even though the leaseholders have accepted the Right of First Refusal, it does not necessarily mean that they will proceed with the purchase. For example, they may decide that the purchase price achieved at auction is too high, leaving them unable to raise the funds. This can be frustrating, to say the least, but unfortunately, it’s out of your control. Leaseholders are not legally required to purchase the freehold until they sign a binding contract, just like any other property sale. Fortunately, if the leaseholders do pull out, proceeding with the auction will enable you to continue with the sale to the highest bidder.
So, with two potential buyers, the leaseholders and the highest bidder, seemingly going head to head, you’re probably wondering by now how this auction malarkey actually works. Well, it’s definitely not like your typical property sale by any stretch of the imagination. In fact, with Section 5B of the Landlord and Tenant Act to adhere to, selling freehold ground rents at auction becomes rather complicated and quite lengthy.
The Section 5B procedure for auctioning freehold ground rents
To get the wheels in motion for disposing of freehold ground rents at auction, it is essential to initially serve Section 5B Notices. If you’ve been intently reading up to this point, you’ll know that Section 5B Notices should only be served if the property and the leaseholders (tenants) qualify. If you skipped over that part, or if you need to refresh your memory, refer back to: ‘What are the qualification criteria for the Right of First Refusal’.
What should a Section 5B Notice contain?
Section 5B Notices must contain the following:
- The principal terms of the disposal proposed by the freeholder
- The property address to which the disposal relates
- The estate or interest in the property proposed to be disposed of
- That the disposal is to be made by means of a sale by public auction
- That the notice constitutes an offer by the landlord which may be accepted by the requisite majority of qualifying leaseholders (tenants) for the contract (if any) entered into by the landlord at the auction to have effect as if the nominated person had entered into it
- The period within which that offer may be accepted – not less than two months from the date of the notice
- The specification of a further period not less than 28 days within which a person(s) may be nominated by the leaseholders to purchase the freehold
Optional inclusions:
- If you know the time, date and location of the auction and are happy for these to be known, you can provide these within the Section 5B Notice. (If you do not include this information, you will have to provide it at a later date.
The notice does NOT need to contain the following:
- The reserve price or deposit required
When should Section 5B Notices be served?
You’ll need to serve the notices between four and six months before the date of the auction and adhere to the following:
- The period specified in the notice as the period which the offer may be accepted must end not less than two months before the date of the auction.
- The period specified in the notice as the period within which a person may be nominated under Section 6 must end not less than 28 days before the date of the auction.
Lastly, if you choose not to disclose the time, date and place of the auction in the notice, you must serve a further notice not less than 28 days before the date of the auction, which provides this information to the requisite majority of qualifying leaseholders.
How long do you have to wait for leaseholders to respond to the Right of First Refusal?
Leaseholders have just two months to accept the Right of First Refusal offer. So, if you don’t receive any correspondence from them within this period, you can go ahead and place your freehold ground rents into the auction.
However, if the leaseholders do wish to accept, they’ll have to let you know with a formal acceptance notice. They’ll then have a further 28 days to inform you of their nominated purchaser and electing that the remaining stages of the Section 5B procedure should apply. Again, leaseholders should do this via a formal notice to the freeholder. Failure to do so will result in the leaseholder’s previous acceptance being deemed withdrawn.
What happens at the auction if leaseholders accept the Right of First Refusal?
This is the all-important question. Your freehold will be placed into the auction as normal, however, the bidders will be made aware that the Right of First Refusal has been accepted. Auction bidders are typically a savvy bunch of people who understand the implications of bidding on a property of this nature. So, although freehold ground rents can be attractive to investors, they are usually reluctant to place their energy into bidding on a property for which leaseholders may exercise their right to buy.
Unfortunately, with a lack of enthusiasm from bidders, it’s likely that you won’t see furious bidding and excitingly high figures arising from the ballroom. This can even mean that the auction fails to achieve your reserve price, in which case you would need to start the entire process all over again. It’s important to note here, that leaseholders do not need to attend the auction nor are they required to bid, so, don’t expect them to bump up the price.
If an acceptable sale price is achieved at the auction, the freehold seller must send a copy of the sale contract to the leaseholder’s nominated purchaser. This contract must be sent within seven days of the auction and provide 28 days for acceptance and for any required deposit to be paid by the nominated purchaser. If these actions are completed, the nominated person will be entered into the sale contract rather than the successful bidder.
However, if the leaseholders withdraw or are deemed to have withdrawn by failing to adhere to legal time limits or procedures, then the sale contract will remain with the successful bidder. Either way, YIPPEE, you’re almost done with your freehold disposal! Furthermore, the leaseholders will be liable for any costs involved if they withdraw (as will you be if you withdraw).
In the unfortunate event that the successful bidder also withdraws, you’ll be free to place the freehold ground rents into another auction within the next 12 months, without consulting the leaseholders. But remember, the sale must continue by auction unless you serve new Section 5 Notices on qualifying leaseholders.
For example, if you decide you’d like to sell your freehold interest privately, you’ll need to issue Section 5A Notices and follow a different set of rules and procedures. Thankfully, the Section 5A procedure is significantly more straightforward and has reduced time constraints compared with Section 5B.
How much does it cost to auction freehold ground rents?
The costs involved with auctioning freehold ground rents vary depending upon the auction company that you choose. Therefore, it’s highly advisable to do plenty of research to ensure that you pay reasonable fees and that you’re using a reputable auctioneer with a track record of selling freehold ground rents.
However, you should expect to pay an initial sum of between £300 and £400 plus VAT. This will cover the inspection and photography of your property together with the publication of the auction catalogue ahead of the sale. On top of this fee, you will be required to pay a commission to the auctioneers. This typically ranges from 1% – 1.5% of the sale price, subject to a minimum fee of around £1000.
What are the advantages and disadvantages of auctioning freehold ground rents?
Advantages
- The auction will set the purchase price on your behalf, so you don’t need to worry about setting a price that is too low or high. Although, a guide price will be recommended by the auctioneer, which is typically low in order to garner interest
- If the bidders are keen, you may be able to achieve a sale price above the market value
- It is possible to exchange contracts on the day of the auction
- Your legal representative will receive a 10% deposit from the successful bidder on the day
Disadvantages
- If leaseholders have accepted the Right of First Refusal, third party buyers may be less likely to bid
- It can be costly to auction freehold ground rents compared with private sales, which do not typically involve any additional costs
- It can take between six to eight months to complete a freehold sale by auction but just three to five months for a private sale
- If the freehold does not sell at auction, you will have to start the notice and sale process all over again, which can delay completion of the sale significantly
Auctioning freehold ground rents can be slightly riskier than other means of disposal, such as selling privately, for example. It also involves a considerably longer process as a result of the legal obligations demanded by Section 5B. So, if you’re looking for a quick and hassle-free sale, selling at auction probably isn’t for you. It’s therefore important to assess your individual requirements and goals before settling on a selling avenue.
Final thoughts
As a freehold investor, I’ve bought and sold many freehold ground rent properties over the last 25 years. This has provided me with vast experience in both private and auction sale processes delivered by a variety of companies. While some of these experiences have unfortunately been on the downright dreadful side, the majority have been pleasant and straightforward. It really is all about choosing the right company; one that is reputable, knowledgeable and can complete the transaction as quickly and efficiently as possible.
Regardless of the selling avenue that you choose, it is absolutely imperative that you follow the Section 5 Notice procedure accurately. If you fail to do so, you can face dire consequences, which are both legally and financially unpleasant.
