Freehold property subject to long leases is normally valued on an investment
basis. In that the freehold interest has no intrinsic value other than
- the rental income (the term)
- the eventual repossession of the property at the end of the term (the
reversion)
so, its value at a given moment is based on a calculated present value of the
future income.
This is comparable to an investment - what sum should be put down today to achieve such
an income for so many years at such a rate of interest, and/or to achieve such a capital
value deferred for so many years.
This achieves a "snapshot" figure of what value this promised income and/or
capital value has today, and is the figure likely to be achieved in an open market sale to
an investor in long term securities.
This is best illustrated by
example:
Assume: a block of 10 flats with 68 years unexpired leases.
The ground rent of each flat is £50 per annum and the individual market value of each
flat with its existing lease is taken as £150,000.
i) calculating the term
Total Ground rent of £50 x 10 flats = £500 pa for the block
This ground rent figure is multiplied by the Years Purchase, a multiplier calculated by
the valuer or, more usually, taken from valuation tables. To obtain the Years Purchase
multiplier, the valuer must make an assumption of a Yield Rate. In this
example the yield is taken as 8%; the Years Purchase figure is then looked up in the
tables.
Years Purchase for 68 years @ 8% is 12.433
So, £500 x 12.433 = £6,216
The calculation produces a figure which it is estimated that a property investor would
be prepared to pay today for a fixed income of £500 per annum for the next 68 years to
produce a yield of 8%. The critical factor in the calculation is the assumed yield
percentage, which the valuer will estimate from a close scrutiny of local freehold auction
prices, calculating back the yield from evidence of what freehold investments have
achieved in the open market. In effect the valuer, being able to see from the particulars
of auctioned properties the unexpired terms and the ground rents and knowing the prices
actually paid, will be able to do the above calculation in reverse producing an indicator
of the yield percentage being achieved. It is important in analysing these transactions
for the valuer to know the individual circumstances of the sale as the base information
obtainable from the auction results may not always provide completely accurate evidence on
which to base other calculations. This can lead to disagreement in estimates of yield
percentage by opposing valuers working from the same local market information. The yield
is a most important element in valuation and one likely to be the subject of difference
between the leaseholders' and landlord's valuers.
ii) calculating the reversion
Current value of the flats = £150,000 x 10 flats
= £1,500,000 (the leaseholders' present
interest).
It is in the nature of a leasehold tenancy for the value to diminish as the lease
expires and a long lease is generally worth more on the open market than a short lease. In
cases enfranchisement, when the enfranchising leaseholders have the opportunity to grant
themselves lease extensions, it can generally be assumed that the action will achieve some
improvement in the value of the individual flats. The amount of this improvement will be
heavily dependent upon the length of the unexpired term before extension and there are no
hard and fast rules as to how much the value will increase. It is this that the valuer
will have to estimate, based on his research into local comparables.
Where the leaseholder has made improvements to the flat which could affect its value these
must be disregarded for the purposes of the valuation. If the improvements are substantial
the valuer will have to calculate the additional value they give to the flat (not what
they cost) and then discount this from the estimated present value of the flat; in effect
the valuer has to assess the unimproved value of the flat.
For the purpose of the calculation of the reversion a value must be ascribed to the
flats representing what they could be sold for when the current term expires. For this
purpose it must be assumed that the most favourable leases will then be granted to
maximise value, e.g. a 999 year term.
(Most long leaseholders have statutory protection to revert to assured tenancies on
the expiry of their existing leases. In the valuation of leasehold interests subject to
protected occupancy the improved value is sometimes discounted by a percentage to reflect
that the landlord will not receive a vacant flat on expiry but a tenant paying a full
weekly rent. This is disregarded for the purposes of the example)
In this example we assume that the acquisition of the freehold would produce an
increase in the market value of the flats equivalent to 10%, representing a future value of each flat of £165,000:-
Improved value: £165,000 x 10 = £1,650,000
Again a multiplier is taken from the tables to provide an investment value - what is
the promise of the future £1.6m worth today? The multiplier, the Present Value
of £1 is taken at the same yield rate, 8%, as previously.
Present value £1 deferred 68 years @ 8% is 0.00534
So,
£1,650,000 x 0.00534 = £8,811
iii) The investment value of the freehold
The investment value of the freehold - the freeholder's interest - is
therefore represented by the sum of the values of the term and the reversion:
£6,216 + £8,811 = £15,027
that is, the sum that the interest is likely to achieve in an open market sale.
The Marriage Value
As described on page 1, marriage value represents the increase in the
value of the flats following the completion of the enfranchisement; their additional
market value arising from the ability of the enfranchising leaseholders to grant themselves
longer leases. In that this potential "profit" only arises from the freeholder's
obligation to sell, the legislation requires that it be shared equally between the parties.
The legislation stipulates that for any flat held by a participating member where the unexpired term of the lease exceeds 80 years any marriage value is to be ignored.
Taking the figures from the previous example above:
| the improved value of the property is |
£1,650,000 |
| from this is subtracted: |
|
| the leaseholders' present interest |
£1,500,000 |
| and the freeholder's interest |
£15,027 |
| In this case the marriage value is |
£134,973 |
Taking the 50:50 split between the freeholder and the enfranchising leaseholders, the
leaseholders would have to pay half this figure - £67,486 - in
addition to the freeholder's interest.
In this example it can be seen that marriage value can considerably exceed the value of
the freeholder's interest. Its calculation is dependent upon the estimated increase in
value of the flats and, clearly, the lower that increase the lower will be the marriage
value. This is an area where the input of a valuer with local knowledge is of paramount
importance to both parties in order to provide substantive comparable evidence of the
local market and how, if at all, flat values will be affected.
The longer the current lease the lower the latent marriage value may be, until
eventually it becomes negligible.
In a Collective Enfranchisement action marriage value is only chargeable in respect of
the flats of the participating leaseholders. The example above assumes all leaseholders
participating for the sake of simplicity. The flats of those leaseholders not participating in
the action are not included in the calculation in that there will be no improvement in the
value of those flats arising from the enfranchisement. (The non-participating leaseholders will
not benefit from the purchase in that they will not be able to extend their leases other
than by the payment of a premium to their new freeholder at a later date). The effect of
this is illustrated by example in the Appendix.
Completing the Valuation
Using the examples above the potential valuation of the building, assuming no extra
costs arising from additional freeholder's interests, or injurious affection, would be the
sum of
| Freeholder's interest |
£15,027 |
| Marriage Value x 50% |
£67,486 |
| Possible purchase price
|
£82,513 |
|
. |
or £8,250 per flat |
The examples assume all leaseholders both qualifying and participating. The examples
are provided solely to demonstrate general working practice in valuation and should not,
of course, be applied in any individual circumstances.
It will be obvious from the examples the areas for differences between the parties,
valuing from their different perspectives, notably
- the yield rate
- the increase in the value of the flats
These differences are illustrated by further examples in the Appendix.
Financial implications for the leaseholder
As can be seen, the share of the cost of the freehold to be paid by the leaseholder
is directly in relation to the potential for increase in the value of the flat. In the
above example, the value of the leaseholder's flat was taken to increase by £15,000 arising
from the payment by the leaseholder of an individual contribution to the purchase price of
£8,250. Therefore the leaseholder has a "profit" from the transaction of £6,750
(less his own and the landlord's costs).
This element of "profit" will, of course, decrease in proportion to the
shortness of the lease, eventually disappearing altogether. It is a matter for the leaseholder
to assess the relative value of proceeding by setting the likely amount he will have to
pay against the resulting increase in the value of the flat. Clearly a leaseholder would be
unwise in negotiating a price in excess of the expected rise in the value of the flat.
Valuing an intermediate interest
In some cases the leaseholders' immediate landlord may not be the freeholder but a
head lessee. The Initial Notice must be served on the head lessee, as well as the
freeholder, and he is entitled to a role in the valuation and negotiation process.
In that the freeholder must deliver an unencumbered freehold title to the RTE Company on
completion of the collective enfranchisement, the head lessee's title will be wound up and
he is entitled to compensation. The overall sum for leaseholders to pay for the freehold will
be the same but it will need to be divided between the two landlords, the freeholder and
the head lessee, in proportion to the value of their relative interests. This may be
agreed between the parties or may be determined by a Leasehold Valuation Tribunal.
Further information on the valuation process is set out in Schedule 6 to the
Leasehold Reform, Housing and Urban Development Act 1993, as amended by the Commonhold and Leasehold Reform Act 2002.
The role of the Valuation Surveyor
The importance of good professional advice has been referred to already but is
worth recapping on the role of the valuer in the procedure.
- to carry out the valuation in accordance with the legislative guidelines
- to advise on the possible purchase price, based on experience and preparation of
"best and worst case" valuations
- to advise on the offer to be made to the freeholder in the Initial Notice
- to advise on the response to the freeholder's Counter-Notice
- to conduct negotiations with the freeholder on behalf of the RTE Company
- to provide expert evidence at the Leasehold Valuation Tribunal
- to provide technical advice on repair and maintenance and cost implications of future
leaseholder management
leaseholders would be most unwise in attempting any enfranchisement
action without early advice from a valuation surveyor, competent in the legislation and
with a good knowledge of the local property market. Once the procedures are
commenced, with the service of the Initial Notice, the participating leaseholders are committed
to proceed and to pay the freeholder's reasonable costs; it is best not to enter this
cycle without the fullest professional advice as to the likely cost and outcome.
Not all surveying practices specialise in this kind of work and leaseholders should make
careful enquiries relating to the practice's experience of the legislation before
proceeding. Advice on local practices can be obtained from the Royal Institution of
Chartered Surveyors or from our list.
Appendix
The calculated valuation is dependent upon certain variable
factors:
- the unexpired term
- the ground rent
- the current and improved values of the flats
- numbers of participating leaseholders
- the yield rate
The following examples will illustrate the potential for change in calculated values
arising from changes in these variables.
The examples are based on the same situation used in the text and the variations can be compared.
Variations - effects on variations
- To recap on the original valuation:
- a block of 10 flats, 68 years unexpired, ground rent £50 pa,
current value £150k, improved value £165k, with all 10 leaseholders
participating
- Freeholder's interest: term £6,216 + reversion £8,811 = £15,027
- Marriage Value £134,973 x 50% = £67,486
- = £82,513
Effect of shorter lease
Assume same situation but with leases of only 35 years unexpired
i)Valuing the Term
- Ground rent x YP 35 years @ 8%*
- £500 x 11.65 = £5,825
ii)Valuing the Reversion
With an unexpired term this short, the increase in value arising will be much greater.
Assume the improved value of each flat remaining at £165,000 but the current value as
much less - say £66,000 or around 40% of freehold value.
- Current value 10 x £66,000
£660,000
- Improved value 10 x £165,000 £1,650,000
- x PV £1 deferred 35 years @ 8% = 0.0676
- = £111,540
- Freeholder's interest
£117,365
iii)Marriage Value
- Improved value
£1,650,000
- less: leaseholders' interest
£660,000
- less: freeholder's interest
£117,365
- = £872,635
- Split 50:50 = £436,317
- Possible purchase price £553,682, or £55,368 per flat
In this case the value of the term is less, with a shorter period of rental income
expected but the reversionary value is very much more - the freeholder has a shorter time
to wait for the property. The increased margin between the current value of a flat with a
short, virtually unsaleable, lease and the improved value has the effect of greatly
increasing the marriage value.
* This yield rate is used for purpose of comparison with the other examples, a
valuer would not necessarily apply this rate to such a short unexpired term.
Effect of a longer lease
Assume same situation but with leases of 95 years unexpired
ii) Valuing the Term
- Ground rent x YP 95 years @ 8%
- £500 x 12.49 = £6,245
ii) Valuing the Reversion
With a long unexpired term of 95 years the value of the flats will already be higher
and it is unlikely that there would be any further increase in market value arising from
the enfranchisement. Therefore the value will be calculated from their current market
value, (taken as £165k) with no improved value applicable.
- Current value 10 x £165,000 = £1,650,000
- x PV £1 deferred 95 years @ 8% = 0.00067
- = £1,105
- Freeholder's interest = £7,350
iii) Marriage value
With the statutory limit on marriage value at 80 years there
will be no marriage value to calculate
In this case the longer term produces a marginally higher value for the term but the
reversion is almost without value.
Effect on the marriage value of different numbers of participating leaseholders
Assume the same situation but only the statutory minimum of participating
leaseholders (half of the total number of flats in the building - assume 5 out of 10)
i) Freeholder's interest - as original example = £15,027
ii) Marriage value - the value of the property will be improved by the assumed increase
in market value of the flats of the participating leaseholders only:
- 5 flats at the assumed improved value of £165,000
- = £825,000
- plus 5 flats at the current value of £150,000 = £750,000
- = £1,575,000
Therefore to calculate the marriage value as before:
| Improved value |
£1,575,000 |
| less: leaseholders' current
interest |
£1,500,000 |
| less: freeholder's interest |
£15,027 |
|
£59,973 |
- Split 50:50 = £29,986
- Possible purchase price £45,013,
- or £9,000 per participating leaseholder
It can be seen that a lower number of participating leaseholders will reduce the amount of
marriage value and, thereby, the overall purchase price, albeit to be shared between a lesser
number of participants.
Effect of differing yield rates
The yield rate assumed by the valuer directly affects the multipliers used in the
calculations and different yield rates will result in differing valuations. It is likely
that the relative perspectives of the landlord's and leaseholders' interests will lead their
valuers to differing conclusions on the appropriate rate.
For the purpose of example, the freeholder's interest (excluding the
marriage value is) recalculated from the original example at rates from 6% to 11%.
Original calculation
|
|
|
using 8%
|
term |
£6,216 |
|
reversion |
£8,811 |
|
|
£15,027 |
Variations
|
|
|
using 6%
|
term |
£8,175 |
|
reversion |
£31,350 |
|
|
£39,525 |
|
|
|
using 7%
|
term |
£7,071 |
|
reversion |
£16,500 |
|
|
£23,571 |
|
|
|
using 9%
|
term |
£5,539 |
|
reversion |
£4,702 |
|
|
£10,241 |
|
|
|
using 10%
|
term |
£4,992 |
|
reversion |
£2,475 |
|
|
£7,467 |
|
|
|
using 11%
|
term |
£4,541 |
|
reversion |
£1,369 |
|
|
£5,910 |
That is, if comparable rates of return, or yields, in the market are
low, a purchaser of the freehold would expect to pay a higher price for the investment,
and vice versa.
Addendum
Changes to Yield Rates