a very anglosphere disaster
leasehold, ground rent and its pathologies
I am putting together more notes for another conference, this time expanding on my half-thought out idea that the business development function of the professional services sector has a way of interacting pathologically with the British political system. In comments to the previous post, I took issue with characterising lawyers and consultants as “rent seeking grifters”, so this week I thought I would look at an adjacent area where no such quibbling is possible, as the entire issue is the literal seeking of literal rent.
A primer for people unfamiliar with the very weird system of land tenure in large and important parts of Britain; we have this thing called “leasehold”, where rather than owning something, you have it on a very long (99 years +) lease. This originated back in the days of primogeniture and all that, and never got changed because we never lost a war badly enough to have our constitutional system properly updated. So lots of people who normally think of themselves as property owners are in fact lessors, and part of the cost of property ownership was always the payment of a “ground rent” to some descendant of a mate of William the Conqueror. This is mainly a London thing, as elsewhere in the country the “freeholds” tended to be bought out for peanuts but in London, people felt that they might be worth hanging on to. The ground rent was also often bundled with a service charge and shared maintenance costs for blocks of flats.
The system was always ripe for abuse, and indeed was abused over the years when freeholders decided to get rapacious, and there have been successive rounds of reforming legislation. But it more or less continued for hundreds of years without creating too great a national scandal. Until …
Part of the trigger appears to have been the aftermath of the Grenfell fire, and the need to review cladding and fire safety on blocks of flats. As well as creating a huge unforeseen cost to leaseholders, this appears to have opened the eyes of a lot of freeholders to the fact that there is next to no regulation of the service charge element of the payments, and so you can inflate them as much as you like with no restrictions on kickbacks from insurance companies, deals with connected parties, or simply paying yourself rent for the office you use and charging it to the other flats.
But a much bigger issue appears to have been the “asset-ization” of freeholds. People have always owned these things as investments, but they didn’t tend to trade much in the past, there wasn’t much transparency and accordingly they didn’t attract much interest from financial investors. Now the “ground rent asset class” has become a thing. And one consequence of this seems to be the same thing that worries me about professional services in general – when the pros move in, people are compensated based on results, and this means that every potential rent-seek becomes and actual rent-seek. Consequently, you suddenly find out exactly how many abuses were always implicitly possible.
And concurrently with this discovery, the very profitability of the rent seeking opportunity creates a powerful lobby group for its preservation. There’s been a bill going through Parliament to basically end the leasehold system, but it’s running into trouble because owners are going to demand compensation for the fully exploited economic value, which of course is much bigger than anyone thought it was.
This feels like a newish pathology of the system to me; it’s not the normal kind of information-processing failure that I usually diagnose in decision making systems, but nor is it exactly the kind of incentive problem that’s easy to model in economics. To an extent, it’s a hybrid of the two; a change in the information system is the explanation for why a massive incentive compatibility failure persisted for so long before it became destructive. Something like the shift in the philosophy of corporate management from “technostructure” to “shareholder value” that happened in the 70s - these shifts are my new big interest.
I have always defended leasehold as a way of recognising the layered nature of property rights, which can help reducing the incentive to rent-seeking, speculative behaviour that property markets attract so readily. Eg many Community Land Trusts use leasehold to limit the price growth of homes and preserve affordability. But that relies on the freeholder being a decent representative of the collective interest, not a spiv... And as Dan says, the weird residual form of leasehold we've ended up is in some ways the worst of all worlds, as it doesn't moderate price growth effectively while still allowing for unsavoury practice that was bad enough when it was a few oddballs and is disastrous in the hands of the pros.
Weirdly I found myself as No 10 adviser when leasehold reform was being proposed, and had to listen to the lobbying of the leasehold industry - which was no more sophisticated than 'we're making a lot of money here - surely you wouldn't want to disrupt that?' But then many of the promoters of leaseholders' interests were pretty unpleasant too: they didn't really object to the property system gouging the poor and the overall economy, they just wanted to be the gougers not the gouged.
This reminds me of the rise of class-action / mass-action litigation in the United States. Essentially for a long time you had a number of different kinds of legal rights that were worth something in the aggregate but worthless to their holders individually because they were too costly to enforce. (You could also say that large corporations were able to aggregate the benefits of violating those rights since they could avoid the costs of compliance, although ideally one would hope that the benefit of compliance to the right-beneficiary exceeds the costs to the right-complier.) Then a change in legal “technology” (if we can call procedural rules that; there is also an element of know-how) made enforcement possible and profitable to some specialized plaintiff-side firms. Then you started to see the professional-service dynamic you talk about where plaintiff-side firms started to develop improved methods of extracting value, some of which look a lot like rent-seeking. And we are all still arguing about which effects predominate from a social value perspective, and good luck figuring it out because practically everyone with an informed opinion also has a relevant financial incentive, an ideological commitment, or both.