At a time of financial stringency and “credit crunch”, coupled with increasing demands by government for greater efficiency, flexibility and innovation, the last thing the Scottish housing market needs is additional restrictions on the funding and products available to it – especially when they are unintended, unnecessary and place both providers and consumers at a disadvantage to their counterparts in the UK and elsewhere.
In this article we examine the impact of the 20 year rule on Scottish housing providers, consider the reasons for the rule and suggest steps to resolve the problems which it causes whilst enabling any benefits to be retained.
What is the 20 year rule?
Put briefly, the 20 year rule provides that: leases of private dwellinghouses are limited to 20 years (the “leases rule”). This includes any right of occupancy granted for payment which is capable of extending for more than 20 years;
a standard security (i.e. mortgage) over a private dwellinghouse may be redeemed on repayment of all money advanced under the security together with interest and expenses after 20 years (the “securities rule”).
The disadvantages of the 20 year rule manifest themselves in a number of areas relevant to the provision of affordable housing in Scotland.
Facilities for housing providers
Housing providers such as registered social landlords (RSLs) generally take out loan facilities for a period of 30 years, or sometimes longer, secured over their housing stock. These facilities will normally contain options to limit interest risk, by either fixing interest rates or entering into other interest-hedging arrangements, all in accordance with proper Treasury management policy.
Due to the nature of the interest hedging process, if the arrangement is terminated prematurely at a time of falling interest rates the lender is likely to suffer certain costs (“breakage costs”) as a result of their own funding arrangements which they will require to pass on to the customer.
However, as a standard security over Scottish housing stock can be redeemed after 20 years subject to payment of principal, interest and expenses only, actual or potential breakage costs which arise after that period will in all probability not be secured. Accordingly, unlike housing providers elsewhere in the UK (and in most other jurisdictions), a Scottish housing provider will either be prevented from, or at least restricted in, fixing or otherwise hedging interest rates which extend beyond a period of 20 years, notwithstanding that there may be good commercial reasons to do so.
The securities rule also prevents a Scottish housing provider from accessing the bond market, possibly as part of a consortium, for a bond in excess of 20 years – a rather shorter period than is normally offered.
Given that the Department of Communities and Local Government is recommending that English RSLs actively consider the bond market as a further option in the current depressed lending market, it would be better if Scottish housing providers had no less ability to access this type of funding than anyone else.
Another method which housing providers in other jurisdictions may use to raise funds is a sale and leaseback of their stock. Such an arrangement would be of extremely limited value if the leaseback could not exceed 20 years.
Home purchase and home reversion plans
The home purchase plan (HPP) is used primarily for Islamic finance arrangements. It involves the lender acquiring either the whole or a proportional interest in the title, with an obligation on the purchaser to acquire the lender’s interest at the end of a set period during which the purchaser will have a right of occupancy subject to making rental/occupancy payments. Lenders’ obligations will often also be covered by a standard security .
As a result of both the leases rule and also the securities rule the HPP cannot, in Scotland, last for over 20 years. In almost every other jurisdiction it will last for as long as the parties agree – usually 25 years – and it is unfortunate and no doubt confusing to those who wish such an arrangement that Scotland cannot offer it on the same terms as would be expected and available elsewhere.
Home reversion plans (HRPs) arise where home owners – usually of retirement age – sell all or a proportional interest in the title to their dwellinghouse with a right to occupy it for the remainder of their lives, or at least until they move into long term care. However under the leases rule this would have to be limited to 20 years, which is clearly unsatisfactory.
Shared equity arrangements
Under a shared equity arrangement, the shared equity provider contributes a proportion of the purchase price in return for a proportion of subsequent sale price or valuation, all secured by a standard security ranking subsequent to that of the primary lender.
Due to the securities rule, however, the shared equity owner can, in Scotland, redeem the standard security after a period of 20 years by unilaterally repaying the original equity contribution plus expenses, leaving the right to capital appreciation unsecured at best and possibly even extinguished.
A similar fate will befall any standard security to secure the obligation to provide a right of first refusal (“pre-emption”) to the shared equity provider outwith the 20 year period.
The net result is that in Scotland, shared equity agreements may only last for a period of 19 years, which again limits flexibility in comparison to other jurisdictions.
Shared ownership arrangements
Shared ownership arrangements involve the sharing owner acquiring a proportional interest in the title to the property, with a right to “staircase” up to full ownership and obtaining a right to occupy the part owned by the housing provider.
Because of the leases rule the occupancy rights cannot be for more than 20 years, whereupon the sharing owner is required to either purchase the entire property, sell his share to the housing provider, or agree a joint sale of the entire property, which is quite different from other jurisdictions where such occupancy rights will last for significantly longer periods. It may also give rise to some unwelcome issues under consumer credit and/or financial services legislation.
Private and public sector tenancies
The rule can also impact on long leases of developments for mixed use where one of those uses is housing, and there have been circumstances where grant providers have wished to fund owners to use property for leases well in excess of 20 years, only to find that they were unable to do so.
There is also an argument that a landlord under a Scottish secure tenancy could terminate the letting after a period of 20 years without cause, which is far from what could ever have been intended and what applies elsewhere, but does seem to be what at least one reading of the legislation provides.
Finally, although uncommon at present, co-ownership arrangements are being discussed elsewhere as a method of providing solutions for affordable housing, having regard to models developed in the USA, Canada, Norway, Denmark, Sweden and a range of other jurisdictions.
Suffice it to say that this type of arrangement will involve periods of lease and security far in excess of 20 years, so will not be capable of even being considered by the Scottish Government whilst the 20 year rule remains in its current form.
Can the rule be mitigated/avoided?
Predictably a number of schemes/arrangements can be put in place in order to seek to either mitigate or avoid the effects of the 20 year rule. To date, none of these have been tested in court, and although some may prove to be valid, it should be borne in mind that courts are increasingly reluctant to uphold devices whose sole or primary purpose is to avoid or weaken the effect of legislation.
In any event, the sector should be characterised by transparency and straightforwardness, not complex avoidance arrangements.
Why was the rule introduced?
The 20 year rule was enacted in 1974 in the statute which prohibited new feuduties. The rationale was that feudal superiors might seek to circumvent this prohibition by creating new sources of income through ground rents and interest payments on long-term leases/standard securities.
Whilst this is unlikely to be a major issue now, it should be borne in mind that the leasing of housing property is commonly regulated in other jurisdictions, with rights sometimes being given to the tenant to extend the term and even to purchase outright.
What is rarely, if ever, controlled elsewhere, and was never intended to be controlled in Scotland, are the restrictions on long term interest hedging, bond funding, shared equity and ownership, Islamic funding, home reversion plans and most if not all of the other matters set out in this paper.
A compromise suggestion
It is clear that the 20 year rule creates a number of anomalous restrictions on the Scottish housing market – including affordable housing – which were neither intended nor even considered at the time when the legislation was passed, and which do not apply in other jurisdictions. This is not a desirable outcome, particularly at a time when Scottish housing providers need a maximum of options and products available to them.
Whilst the Scottish Government may not wish to go for a root and branch repeal of the 20 year rule at this stage, they could resolve most if not all of the difficulties and anomalies noted here by amending the legislation to enable exceptions to the rule to be created by secondary legislation and/or by ministerial determination.
An early review would certainly not go amiss.
Len Freedman and Professor Robert Rennie are partners in Harper Macleod LLPo
In this issue
- Discrimination is discrimination
- Servitudes and shop fronts
- DLA Piper in expansion mode
- At your service
- ARTL and secure signatures
- Sending a unified message
- Facing the squeeze
- Room for doubt
- Dealing with our older casework
- Regime change
- Risky business
- Drink problems
- Consumer credit licence changes
- RFPG's online trainee service
- Adult incapacity: new caution scheme agreed
- Appreciation: Sandy McIlwain
- Stair Memorial marks its 21st
- "Gateway" opens its doors
- Facing the lean years
- On the road again
- E-legal @ Nothing but the Net
- IT - ever onwards
- Testing competency
- A Wise decision
- Name calling
- Diverse guidance
- Tackling the sporting bodies
- Keeping it legal
- Scottish Solicitors' Discipline Tribunal
- Website reviews
- Book reviews
- Charging the death offences
- Another hoop to jump
- An idea whose time has gone
- Society launches home report solution