The premium to be paid for the new lease, according to Schedule 13, Part II of
the Leasehold Reform, Housing and Urban Development Act 1993 as amended by the Commonhold and Leasehold Reform Act 2002, shall be the total of:
- the diminution in the value of the landlord's interest in the flat;
that is, the difference between the value of his interest now with the present lease and
the value of his interest after the grant of the new lease with the extra 90 years.
- the landlord's share of the marriage value
- compensation for loss arising from the grant of the new lease.
The diminution in the value of the landlord's interest is,
effectively,
- the loss of the income from the ground rent for the remainder of the original term (as
the whole term of the new lease will be at peppercorn rent)
- the loss due to the additional 90 years wait for the reversion (the surrender of the
flat at the expiry of the term)
The marriage value is taken as the potential for increase in
the value of the flat arising from the grant of the new lease and the Act requires that
this "profit" shall be shared between the parties. The proportion of the split
of Marriage Value is fixed by the legislation at a 50:50 division between landlord and leaseholder. In the calculation of the Marriage Value the leaseholders' and
landlord's valuers will rely on local knowledge and experience to assess the increase in
value in the flat arising from the new lease.
The compensation is to provide remedy to the landlord for any
other diminution in the value of his interest in other property (other flats in the
building or the building itself) and any loss or damage arising from the grant of the new
lease. It is difficult to find examples of where a landlord could claim compensation since
he will, in most cases, retain the freehold. Probably the only possibilities could be a
claim for loss of opportunity for redevelopment potential or for a reconversion of a house in flats back to a single dwelling house.
The Act does not require a formal valuation to be carried out but it would be prudent
to obtain one. The valuation will provide the basis for the leaseholder's offer to the landlord
contained in the leaseholder's Notice. The offer does not need to be the same as the valuation,
and there is no legal obligation to reveal the details of the valuation.
The landlord may accept the leaseholder's offer or respond, in his Counter-Notice, with his
own asking price. It is to be hoped that the parties will then enter into negotiation and
settle the premium. If this cannot be achieved then either party may make application to
the Leasehold Valuation Tribunal, in accordance with the set timescales.
The Leasehold Valuation Tribunal will, after hearing the submissions of both parties,
determine all outstanding issues relating to the premium:
- the diminution in the value of the landlord's interest
- the amount of the marriage value
- the proportional split of the premium where there is an intermediate landlord
- the amount of compensation (if any)
The LVT's role is not to decide in favour of either party's valuation but to determine
the issues independently; the Tribunal's determination may not, therefore, necessarily
reflect the prices proposed by either the leaseholder or the landlord.
More information on LVT procedures is
contained in our leaflet "Application to the LVT"
The legislation requires that the value of the interest to be acquired should be
determined in accordance with general market values - assuming a willing vendor and a
willing purchaser. The principles of the Act are not to provide a forced bargain for the
leaseholder but adequately to compensate the landlord for the loss or diminution in value of
his property - a fair price based as closely as practicable on open market values. The
essential difficulty is the assessment of an "open market value" in the
artificial situation created by the imposition of the leaseholder's rights.
Principles and methods
Valuation is an imprecise science, based as it is on the application of
methodical calculation to a combination of known and assumed information. Certain facts
are known, the outstanding term of the lease and the amount of ground rent payable; to
this the valuer has to provide the current market value of the flat or flats, the likely
improvement in that value following the grant of the new lease and estimate a yield rate
for calculation.
The valuer will have to rely on his experience and close monitoring of the local
property market to produce meaningful figures but, it must always be appreciated that
property valuation cannot produce definitive values, no matter how skilled or experienced
the valuer. The valuation will always be the best estimate based on market forces - what a
purchaser will be prepared to pay - and it is almost inevitable in valuations for 1993 Act
procedures that the leaseholders' valuation and the landlord's valuation will be some way
apart. A good valuer will be able to anticipate the likely variations and to advise his
client at an early stage, whilst being able to support his own valuation.
Freehold Property
Freehold property subject to long lease 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)
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 a rate of interest, and/or to achieve such a capital value
deferred for so many years.
In a valuation for a lease extension what is calculated is the diminution in the
landlord's interest arising from the extension of the term at a peppercorn rent. This is
represented by the loss of the ground rent for the remaining period of the existing lease
and the extra 90 years delay in achieving the reversion.
This is best illustrated by example:
Assume: a
flat with 68 years unexpired lease. The ground rent of is £50 per annum and the present
market value of the flat with its existing lease is taken as £150,000.
i) calculating the term
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 (see below). 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% - 12.433
- Ground rent £50 x 12.433 = £621
The calculation produces a figure which it is estimated that a property investor would
be prepared to pay today for a fixed income of £50 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 leaseholder's and landlord's valuers.
The yield rate used in this note is for purposes of example only and does
not purport to represent actual market rates. The effect on the valuation of differing
yield rates is demonstrated in the Appendix.
ii) calculating the reversion
- Current value of the flat = £150,000 (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 of lease extension it can generally be assumed that the action will achieve some
improvement in the value of the flat. 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
flat representing what it could be sold for when the current term expires. For this
purpose it must be assumed that the most favourable lease 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 often 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 improvement could produce an increase in the market
value of the flat of around 10%, representing a future value of £165,000:
Again a multiplier is taken from the tables to provide an investment value - what is
the promise of the future £165,000 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% - 0.00534
- So, £165,000 x 0.00534 = £881
Aggregating the diminution in the landlord's interest
The diminution in the interest is calculated as the value of the present term and
reversion, less the value of the reversion at the end of the new
term. This is usually so small as to be disregarded:
- Reversion to capital value after the grant of the extension
- PV £1 deferred 158 years (68 + 90) is 0.000000069
- So, £165,000 x 0.000000069 = nil
Therefore the diminution in the landlord's interest is:
-
| term |
£621 |
| plus: reversion at 68 years |
£881 |
| less: reversion at 158 years |
£nil |
|
= £1,502, say £1500 |
The Marriage Value
As described on page 2, marriage value is the increase in the value of the
property following the completion of the lease extension, reflecting the additional market
value of the longer lease. In that this potential "profit" only arises from the
landlord's obligation to grant the new lease, the legislation requires that it be shared equally between the parties.
The calculation of the marriage value, according to Schedule 13, is the difference
between two aggregate amounts, which are:
| i) |
the value of the leaseholder's interest under the present lease |
| plus |
the value of the landlord's interest prior to the grant of the new lease |
| plus |
the value of any intermediate interests |
| ii) |
the value of the leaseholders interest with the new lease |
| plus |
the value of the landlord's interest once the new lease is granted |
| plus |
the value of any intermediate interests (if remaining) |
The legislation stipulates that where the unexpired term of the lease exceeds 80 years the marriage value shall be taken to be nil.
Taking the figures from the example the calculation will be:
| i) leaseholder's present interest |
= £150,000 |
| plus landlord's present interest |
= £1,500 |
|
= £151,500 |
| ii) leaseholder's new interest |
= £165,000 |
| plus landlord's new interest |
= £nil |
|
= £165,000 |
The Marriage value is therefore £165,000 minus £151,500 = £13,500
Taking the 50:50 split between the landlord and the leaseholder, the leaseholder would have to
pay half this figure - £6,750 - in addition to the diminution in
the landlord's interest.
In this example it can be seen that Marriage Value can considerably exceed the value of
the landlord's interest. Its calculation is dependent upon the estimated increase in value
of the flat 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.
Completing the Valuation
Using the examples above the potential valuation of the new lease, assuming no extra
costs arising from intermediate interests, or compensation, would be the sum of
| Diminution in the Landlord's interest = £1,500 |
| marriage value x 50% = £6,750 |
| possible premium = £8,250 |
This example is 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 example the areas for differences between the parties,
valuing from their different perspectives, notably
- the yield rate
- the increase in the value of the flat
These differences are illustrated by further examples in the Appendix.
Financial implications for the leaseholder
As can be seen, the amount of the premium 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 a premium 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 premium he will have to pay against the
resulting increase in the value of the flat. Clearly a leaseholder would be unwise in
negotiating a premium in excess of the expected rise in the value of the flat.
Intermediate interests
In some cases the leaseholder's immediate landlord will not be the competent
landlord for the purposes of the application, only having a headlease. Therefore the
calculation of the premium payable by the leaseholder will have to take into account the effect
of the grant of the new lease on both landlords' interests, the immediate landlord and the
freeholder. The overall sum for the leaseholder to pay will be the same but it will need to be
divided between the two landlords.
Valuing the interests
It is quite common for the intermediate landlord's lease to be only a few days
superior to that of the leaseholder's, that is it comes to an end shortly afterward.
In this situation the only diminution in the intermediate landlord's interest comes from
the loss of the rental income for the remainder of the term. The intermediate landlord has
no reversionary value, or so little as to be disregarded and so the value of the reversion
will represent the diminution in the freeholder's interest. Applying this to the original
example (and disregarding any ground rent paid by the intermediate landlord to the freeholder), the diminution in the two interests would be: (figures rounded down)
| the intermediate landlord (the loss of the rent) |
£620 |
| the freeholder (the delayed reversion) |
£880 |
The overall diminution in the value of the landlord's interests would be the same from
the leaseholder's point of view but the £1,500 total would be divided between the two of them.
Where there is a marriage value it must also be split between the two landlords. This
must be in proportion to the amounts by which their individual interests are diminished,
in this case apportioned to a ratio of 620 to 880: Using the example, where the landlords'
share of the marriage value was calculated at £6,750 the distribution would be:
- the intermediate landlord : £6,750 x 620 = £2,790
-
1500
-
- the freeholder :
£6,750 x 880 = £3,960
-
1500
Therefore the division of the leaseholder's premium between the landlords is:
Intermediate landlord
| Diminution in interest |
= £620 |
| Share of marriage value |
= £2,790 |
|
= £3,410 |
Freeholder
| Diminution in interest |
= £880 |
| Share of marriage value |
= £3,960 |
|
= £4,840 |
| Total premium |
= £8,250 |
Further information on the valuation process is set out in Schedule 13 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 a valuation to assess the premium in accordance with Schedule 13
- to advise on the offer to be made to the landlord in the leaseholder's Notice
- to advise on the response to the landlord's Counter-Notice
- to conduct negotiations with the landlord on behalf of the leaseholder
- to provide expert evidence at the Leasehold Valuation Tribunal, if necessary
A leaseholder would be unwise in attempting any lease extension 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
leaseholder is committed to proceed and to pay the landlord's reasonable costs; it is best not
to enter this cycle without 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
As stated previously the calculated valuation is dependent upon certain
variable factors:
- the unexpired term
- the ground rent
- the current and improved values of the flat
- 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 valuation
To recap on the original valuation:
- a flat with 68 years unexpired, ground rent £50 pa, current value £150k,
improved value £165k
- Landlord's interest: Term £620 + Reversion £880
- = £1,500
- Marriage Value £13,500 x 50% = £6,750
- = £8,250
Effect of shorter lease
Assume same situation but with a lease of only 35 years unexpired
i) Valuing the Term
- Ground rent x YP 35 years @ 8%*
- £50 x 11.65 = £582
-
ii) Valuing the Reversion
With an unexpired term this short, the increase in value arising will be much greater.
Assume the improved value remaining at £165,000 but the current value as much
less - say £66,000 or around 40% of long-lease value
- Improved value = £165,000
- x PV £1 deferred 35 years @ 8% = 0.0676
- = £11,154
- Landlord's interest = £11,736
-
iii) Marriage Value
- Improved value = £165,000
- less: Leaseholders' interest £66,000
- less: landlord's interest £11,736
- = £87,264
- Assume split 50:50 = £43,632
- Possible premium £55,368
-
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 landlord 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 purposes 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 a lease of 95 years unexpired
i) Valuing the term
- Ground rent x YP 95 years @ 8%
- £50 x 12.49 = £624
-
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 the current market value,
(taken as £165k) with no improved value applicable.
- Current value x £165,000
- x PV £1 deferred 95 years @ 8% = 0.00067
- = £110
- Landlord's interest = £734
-
iii) Marriage Value
With the statutory limit on marriage value at 80 years, there will be no marriage value.
- Possible premium = £734
-
In this case the longer lease may produce a marginally higher value for the term but
the reversion is almost without value.
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 |
£620 |
|
reversion |
£880 |
|
|
£1,500 |
|
|
|
Variations
|
|
|
using 6%
|
term |
£817 |
|
reversion |
£3,135 |
|
|
£3,952 |
|
|
|
using 7%
|
term |
£707 |
|
reversion |
£1,657 |
|
|
£2,364 |
|
|
|
using 9%
|
term |
£554 |
|
|
reversion |
£470 |
|
|
|
£1,024 |
|
|
|
|
using 10%
|
term |
£499 |
|
reversion |
£253 |
|
|
£752 |
|
|
|
using 11%
|
term |
£454 |
|
reversion |
£137 |
|
|
£591 |
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