Why buying a flat is not always the best choice
Flat Ownership in Britain: Pros and Cons
The Property Ladder Trap
For aspiring first-time buyers or property investors seeking their next opportunity, the current housing market demands careful consideration to ensure a wise investment. Higher mortgage rates since 2022 have forced buyers to meticulously evaluate their budgets and realistic repayment capabilities. Despite the lack of substantial house price declines to offset the increased borrowing costs, flat ownership has long been a popular choice for keeping expenses down. However, leasehold issues and new-build development disasters have left many buyers financially trapped, raising the question: are flats still a good investment?
Mortgage Approval: Additional Scrutiny
When deciding whether to approve a home loan, lenders often apply additional scrutiny when evaluating a flat purchase. Their primary concern is gaining a comprehensive understanding of the associated risks, including the likelihood of reselling the property. Key considerations include the flat’s square footage, height, accessibility, and risks posed by shared communal spaces. Lenders also assess the property’s value, as flats are less likely to hold their value and experience slower growth rates compared to other property types.
Lending Limitations and Schemes
Prospective buyers may face borrowing limitations when purchasing a flat relative to a house. Lenders often cap the loan-to-value ratio for flats at 90%, requiring a 10% deposit, compared to 95% for houses, necessitating a larger upfront savings. Furthermore, while schemes and mortgage products cater to first-time buyers, some exclude new-build flats or rule out flats altogether, due to concerns about buyers falling into negative equity.
New-Build Flats: Premiums and Warranties
New-build apartments warrant extra scrutiny from lenders due to the “new-build premium.” Once occupied, these properties immediately depreciate in value, making them harder to remortgage or resell down the line. Buyers should negotiate prices with developers, compare with similar properties, and request a breakdown of the asking price to identify any add-ons that lenders may not ascribe value to, potentially leading to a down valuation.
Additionally, buyers should be aware of new-build warranties, which are often insurance policies with excesses and exclusions for workmanship issues. Lenders may also halt lending on specific apartment buildings to mitigate concentrated risk.
Cladding Considerations
In the aftermath of the Grenfell fire tragedy, buildings covered in flammable cladding have been nearly impossible to mortgage. However, as of December 2022, major high street lenders announced their willingness to lend on flats with cladding if developers commit to fixing the issue, the property is covered by a recognised government scheme, or if leaseholder protections are in place under the Building Safety Act.
The Leasehold Conundrum
A significant aspect of flat ownership is the leasehold arrangement. In England, 82% of privately owned flats are leasehold, meaning the land the flat is built on is owned by a freeholder. Leaseholders must pay ground rent and annual service charges to the freeholder for maintenance. Despite pledges to end leaseholds, the system remains largely unchanged, and flats are exempt from the proposed ban on new leaseholds.
Certain leasehold agreements include clauses allowing for ground rent doubling every 10 years, trapping leaseholders in properties they can no longer afford but cannot sell or remortgage. Service charges can also lack transparency, with freeholders selecting providers without consulting leaseholders.
Leasehold terms typically range from 99 to 999 years, and properties often lose value as the remaining lease term decreases. Buyers should factor in the likelihood of paying ground rent and service charges for the duration of their ownership.
Insurance Considerations
Insurance requirements differ for freehold and leasehold flat owners. While building insurance is usually covered by the freeholder, freehold flat owners must secure and pay for it themselves. However, the Fire Safety Reinsurance Facility introduced this year aims to reduce insurance costs for individual flat owners, particularly those with cladding issues.
Both leasehold and freehold owners require contents insurance and should consider additional coverage for potential flooding or security risks based on the flat’s location and building’s security measures.
The Outlook for Flats
Despite the challenges, flats offer a route to property ownership for many unable to afford houses, especially in the current market with high interest rates and low housing stock. Developers often provide incentives such as deposit boosters to assist first-time buyers.
Furthermore, the gap in price growth between flats and houses is narrowing, according to Tom Bill, head of UK residential research at Knight Frank. He suggests that the outlook for flats and houses is unlikely to differ significantly, although leasehold flats face ongoing uncertainty. Regional variations also play a role, with prices in areas like London constrained by affordability factors.
Weighing the Options
While flat ownership presents potential pitfalls, it remains a viable option for those seeking to enter the property market or expand their investment portfolio. Prospective buyers should carefully evaluate the associated risks, costs, and regional market dynamics before making an informed decision. By understanding the nuances of leasehold agreements, new-build considerations, and lending criteria, individuals can navigate the flat ownership landscape with confidence and make a well-informed investment.
Summary
• Flats have long been a popular option for affordable home ownership, but leasehold issues and new-build problems have trapped some buyers financially
• Lenders apply extra scrutiny to flats, considering factors like size, height, accessibility, shared spaces, and resale value
• Buyers may face lending limits on flats, with lower maximum loan-to-value ratios requiring larger deposits
• Some mortgage schemes exclude new-build flats over risk of negative equity
• New-build flats depreciate immediately after purchase and can be difficult to remortgage/resell
• Flammable cladding made many flats unable to be mortgaged until lenders relaxed rules in late 2022
• 82% of private flats in England are leasehold, requiring ground rent and service charge payments
• Leasehold terms run down over time, reducing the property’s value as remaining lease shortens
• Leasehold clauses like doubling ground rent can make flats unaffordable for owners
• Freehold flat owners must arrange their own building insurance
• Price growth gap between flats and houses is narrowing, but regional affordability impacts flat market
• Flats still offer a route to ownership for many priced out of housing market