This booklet is not meant to describe or give a full interpretation of the law, as only the courts can do that. And it does not cover every case. If you are in any doubt about your rights and responsibilities, you should get advice from a solicitor who specialises in this area of the law.
If you are considering extending your lease, one of the first questions to ask is ‘How much will it cost?’ The valuation process required by the law is complicated, so at the beginning of the process it is often very difficult to form a clear view of exactly how much it will cost to extend the lease.
This advice note aims to describe:
- how the law says the price must be made up;
- the general principles and methods of valuing the landlord’s interest in the property; and
- the role of the professional valuer in the process.
This note is not intended as a ‘do-it-yourself’ guide to valuing your own lease extension. You should get proper professional advice as early in the process as possible.
- the reduction in the value of your landlord’s interest in the flat (that is, the difference between the value of your landlord’s interest now with the current lease and the value of their interest after the new lease is granted with the extra 90 years);
- your landlord’s share of the marriage value (see below); and
- compensation for any losses your landlord suffers as a result of the new lease being granted.
The reduction in the value of your landlord’s interest is:
- compensation for any losses your landlord suffers as a result of the new lease being granted.
- the income they will lose from the ground rent for the rest of the original term, as the whole new lease will be at a peppercorn rent (a very low or nominal rent); and
- the loss they suffer due to the extra 90 years they will have to wait for ownership of the flat to transfer back to them at the end of the lease (known as reversion).
The marriage value is the possible increase in the value of the flat arising from the new lease. The act states that the marriage value should be shared equally between you and your landlord. When calculating the marriage value, your valuer and the landlord’s valuer will rely on local knowledge and experience to assess the increase in the value of the flat arising from the new lease.
The compensation is to make up for any other reduction in the value of your landlord’s interest in other property (other flats in the building or the building itself) and any loss or damage arising from the new lease being granted. It is difficult to find examples of where a landlord could claim compensation since, in most cases, they will keep the freehold and so there will be no need for compensation. Probably the only situation where compensation may be necessary would be a claim for loss of opportunity to redevelop a site or to convert a house which has been converted to flats back to a single house.
The act does not say that a formal valuation has to be carried out, but it would be wise to get one. The offer you make to your landlord in the tenant’s notice will be based on the valuation. It doesn’t have to be the same as the valuation, and you do not have to reveal the details of the valuation.
Your landlord may accept your offer or suggest their own asking price in a counter-notice. Hopefully you and your landlord will then negotiate and agree the price for the new lease. If you cannot agree on the price, you or your landlord can apply to the First-tier Tribunal (Property Chamber) which has the power to decide the price if it cannot be agreed otherwise.
- the reduction in the value of your landlord’s interest;
- the amount of the marriage value;
- how the price will be shared between the landlords if there is an intermediate landlord; and
- the amount of any compensation.
The tribunal’s role is not to decide in favour of either your of your landlord’s valuation, but to make an independent decision. So, the tribunal’s decision may not necessarily reflect either of the prices you or your landlord proposed.
By law, the value of the interest you will gain as a result of the new lease should be calculated as if the lease were being sold on the general market by a willing seller to a willing buyer. The principles of the act are not to provide a bargain for you, but to adequately compensate your landlord for the reduction in the value of their property, by making sure you pay a fair price based as closely as possible on open-market values. It is difficult to assess an open-market value in the artificial situation created by the need to protect your rights.
Principles and methods
Valuation is not an exact science, as it is based on a calculation using a combination of known and assumed information. The valuer will know certain facts (how long is left on the current lease and how much the ground rent is) and will use these to provide the current market value of the flat and the likely increase in that value when the new lease is granted, and will estimate a yield rate for the calculation. (The yield rate is the rate of return that buyers, at the valuation date, are seeking in relation to the particular interest in that type of property, of that investment quality, in that location. It is derived from market evidence).
The valuer will use their experience and monitor the local property market closely to produce meaningful figures. But you must always remember that property valuations cannot produce final values, no matter how skilled or experienced the valuer is. The valuation will always be the best estimate based on what a buyer would be prepared to pay, and it is almost certain that your valuation and the landlord’s valuation will be different. A good valuer will be able to anticipate the likely differences and advise you on this at an early stage, while still being able to support their own valuation.
- the rental income (the term); and
- the eventual value of the property at the end of the lease when ownership transfers back to the landlord (the reversion value).
So the value of the freehold at any given time is based on calculating the current value of the future income.
This is similar to an investment – how much should be invested today to achieve such an income for so many years at such a rate of interest?
In a valuation for a lease extension, what is calculated is the reduction in the landlord’s interest as a result of extending the lease at a peppercorn rent. This is calculated as the amount of ground rent the landlord would have received for the remaining period of the existing lease (the term) and the extra 90 years the landlord will have to wait until ownership of the property will return to them (the reversion value).
The valuation procedure can be illustrated by an example using the following assumptions.
- A flat has 68 years left on the lease, a ground rent of £50 a year and a current market value (with the existing lease) of £150,000.
Calculating the term (the ground rent the landlord would expect to receive over the life of the existing lease)
This ground rent figure is multiplied by the ‘years purchase’, which is a multiplier calculated by the valuer or, more usually, taken from valuation tables. Years’ purchase is tied to the principle of inflation, and the fact that, in general, money will buy less in the future than it does now. It is a multiplier which is calculated through the setting of a yield (or other variable) and a number of years. To find the years purchase multiplier, the valuer must make an assumption of a yield rate (see above). In this example, the yield is 8%. The valuer can then look up the years purchase figure in the valuation tables.
- Years purchase for 68 years at 8% is 12.433.
- The ground rent is then multiplied by the years purchase (£50 x 12.433 = £622).
The calculation above produces a figure which it is estimated that a property investor would be prepared to pay today for a fixed income of £50 a year for the next 68 years to produce a yield of 8%. The important factor in the calculation is the assumed yield rate, which the valuer will estimate after closely examining local freehold auction prices, calculating the yield from evidence of what freehold investments have achieved on the open market. Using the details of auctioned properties (the number of years left on the leases relating to those properties, the ground rents, and the prices that the properties actually sold for), the valuer will be able to do the above calculation backwards to find out the yield rate being achieved. When analysing these sales, it is important for the valuer to know the individual circumstances of the sale, as the information they get from the auction results may not always provide completely accurate evidence which they can base other calculations on. This can lead to differences in estimates of yield rate by your valuer and your landlord’s valuer, even if they are using the same local-market information. The yield rate is an important detail in valuations and one that your and your landlord’s valuers are likely to disagree on.
The yield rate used in this calculation is an example only. It does not represent actual market rates.
Calculating the reversion value
Current value of the flat = £150,000
(the leaseholder’s current interest)
With a leasehold tenancy, the value of the property reduces as the time left on the lease runs out, 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 extending the lease will increase the value of the flat. How much the value increases by will depend on how long is left on the lease before it is extended, and there are no rules as to how much the value will increase. It is this increase in value that the valuer will have to estimate, based on the evidence they have on local property sales.
If you have made improvements to the flat which could affect its value, the valuer must disregard these for the purposes of the valuation. However, for major improvements, the valuer will have to calculate the extra value the improvements give to the flat (not what they cost), and then deduct this from the estimated current value of the flat to assess the unimproved value of the flat.
When calculating the reversion value, valuers must give the flat a value to represent what it could be sold for when the current lease ends. To do this they must assume that the most favourable lease will be granted to produce the maximum value, for example, a 999-year lease.
(Most long leaseholders are protected by law and will be entitled to assured tenancies when their existing leases end. (This is known as ‘protected occupancy’.) In the valuation of a landlord’s interests where the leaseholder has protected occupancy, the improved value is sometimes reduced by a percentage to reflect the fact that the landlord will not receive a vacant flat at the end of the lease, but a tenant who will be paying a full weekly rent. We have not included this for the purposes of the example in this guide.)
In this example we assume that granting a new lease could produce an increase in the market value of the flat of around 10%, which would produce a future value of £165,000.
Again, the valuer uses a multiplier from the valuation tables to provide an investment value (what the promise of the future value of £165,000 is worth today). The multiplier, the Years’ purchase figure, is taken at the same yield rate, 5%. Following a case known as Sportelli, a deferment rate of 5% was set nationally. This rate is used to determine the present value of an asset which consists only of the right to vacant possession of a particular residential property at the end of the lease in which the freehold is located. There have been several cases that have successfully challenged this, so we are using the 5% rate for the purpose of the example only.
Current value of £1 for 68 years at 5% is 0.03623.
So, £165,000 (future value) x 0.03623 = £5,978
Calculating the reduction in the landlord’s interest
The reduction in the landlord’s interest is calculated as the value of the current term plus the reversion value, less the reversion value at the end of the new lease. This is usually so small it is often disregarded.
Reduction in the capital value after the lease is extended:
Current value of £1 for 158 years (number of years left on the current lease (68) + (number of years the lease will be extended by (90)) is 0.0004488.
So, £165,000 (future value) x 0.0004488 = £74
So, the reduction in the landlord’s interest is:
|plus: reversion at 68 years||£5,978|
|less: reversion at 158 years||£74|
The marriage value
As described above, the marriage value is the increase in the value of the property following the lease extension. It reflects the increased market value of the longer lease. Because this potential ‘profit’ only arises as a result of the landlord’s obligation to grant the new lease, by law it must be shared equally between the landlord and the leaseholder.
According to schedule 13 of the act, the marriage value is the difference between two amounts, which are:
- the value of the leaseholder’s interest under the current lease
plus the value of the landlord’s interest before the new lease is granted
plus the value of any intermediate interests (that is, an intermediate leaseholder holding a leasehold interest who is also the landlord under another lease of all or part of the same property); and
- the value of the leaseholder’s interest with the new lease
plus the value of the landlord’s interest once the new lease is granted
plus the value of any remaining intermediate interests.
The act states that if more than 80 years are left on the current lease, the marriage value will be zero. In other words, no marriage value will be paid if more than 80 years are left on the lease when the leaseholder applies to extend it.
Taking the figures from the example, the calculation will be as follows.
|the leaseholder’s current interest||= £150,000|
|plus landlord’s current interest||= £6,600|
|the leaseholder’s new interest||= £165,000|
|plus landlord’s new interest||= £74|
The marriage value is £165,074 minus £156,600 = £8,474
Because the marriage value has to be shared equally between the landlord and the leaseholder, the leaseholder would have to pay the landlord half this figure (£4,237) on top of the reduction in the landlord’s interest.
As this example shows, the marriage value can be considerably more than the value of the landlord’s interest. It depends on the estimated increase in the value of the flat – the lower that increase, the lower the marriage value. It is vital for both your valuer and your landlord’s valuer to have knowledge of the local housing market so they can provide evidence of local property sales and how, if at all, flat values will be affected.
Completing the valuation
Using the examples above and assuming there are no extra costs arising from intermediate interests or compensation, the valuation would be the reduction in the landlord’s interest plus half of the marriage value.
|reduction in the landlord’s interest||= £6,526|
|plus half of the marriage value (£8,474 ÷2)||= £4,237|
|possible price of the new lease||= £10,763|
We have provided this example to show how valuation works in general. You should not use it to value your lease.
- the yield rate for both the term and the reversion value; and
- the increase in the value of the flat.
There are more examples which show these differences in the Appendix.
Financial implications for you
As you can see from the example, the amount you must pay for the new lease is directly related to the possible 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 as a result of the leaseholder paying £10,800 to extend the lease. This would give the leaseholder a ‘profit’ of £4,274 (less their and the landlord’s costs).
The shorter the lease, the lower this ‘profit’ will be, until it eventually disappears altogether. You must assess the value you may gain by comparing the price you will have to pay for the new lease against the increase in the value of the flat that the new lease will create. Clearly it would be unwise to agree a price that will be more than the expected increase in the value of your flat.
In some cases your immediate landlord will not be the competent landlord for the purposes of the application, and will only have a headlease. The competent landlord, who is usually the freeholder, is the landlord whose interest is long enough to grant the 90-year lease extension you are entitled to.
If your immediate landlord is not the competent landlord, the calculation of the price of the new lease will have to take account of how granting the new lease would affect both landlords’ interests (the immediate landlord and the freeholder). The overall price you would pay will be the same, but it will need to be divided between the two landlords.
The role of the valuation surveyor
We have already mentioned the importance of good professional advice. In the procedure for extending a lease, the valuer’s role is to:
- carry out a valuation to assess the price in line with schedule 13;
- advise you on how much to offer your landlord in the tenant’s notice;
- advise you on how to respond to your landlord’s counter-notice;
- negotiate with your landlord on your behalf; and
- provide expert evidence at the First-tier Tribunal (Property Chamber), if necessary.
It would be unwise to apply to extend your lease without getting advice at an early stage from a valuer (a valuation surveyor who is familiar with this area of the law and has a good knowledge of the local property market).
Once you give your landlord your offer in the tenant’s notice, you must continue with the process and pay your landlord’s reasonable costs, so it is best not to do this without first getting professional advice about the likely cost and outcome.
Not all surveyors specialise in this kind of work, and you should make careful enquiries about the surveyor`s experience of the law before asking them to provide a valuation. For advice on surveyors who specialise in this area of the law, please contact the Royal Institution of Chartered Surveyors.
As we have already mentioned, the valuation depends on the following figures, which will vary from case to case.
- How long is left on the current lease
- The ground rent
- The current value of the flat and the improved value with the extended lease
- The yield rate
The following examples will illustrate how variations in the figures above may affect possible valuations.
The examples are based on the same situation used in the text above, and will allow you to compare the effect of the variations.
How variations in certain figures will affect a valuation
To recap on the original valuation:
The landlord’s interest is the term plus half of the marriage value:
plus the reversion value (£5,978)
less the proposed interest (£74)
half of the marriage value (£8,474 ÷ 2) = £4,237
£6,526 + £4,237 = £10,763
Effect of a shorter current lease
Assume the same situation but with only 50 years left on the current lease.
- Calculating the term
Ground rent x years purchase for 50 years at 8%
£50 x 12.233 = £612
- Calculating the reversion value
With such little time left on the current lease, the increase in value as a result of the new lease will be much higher.
Assume the improved value stays the same at £165,000, but the current value is much lower than in the example above (say £95,700 or around 58% of the improved value).
Improved value = £165,000
x current value of £1 for 50 years at 5% = 0.0872
- Calculating the marriage value
Improved value = £165,000
plus proposed interest £182
less the leaseholder’s interest £125,000
less the landlord’s interest £15,000
In this case the value of the term is less, with a shorter period of rental income expected, but the reversion value is much more as the landlord has less time to wait for ownership of the property to pass to them.
The yield rates in the examples are for comparison with the other examples only, and a valuer would not necessarily use these rates.
Effect of a longer current lease
Assume the same situation but with 95 years left on the current lease.
- Calculating the term
Ground rent x years purchase for 95 years at 8%
£50 x 12.49 = £625
- Calculating the reversion value
With 95 years left on the current lease, the value of the flat will already be higher than in the other example, and it is unlikely that there would be any further increase in market value arising from extending the lease. So the value will be calculated from the current market value (£165,000), with no increased value.
Current value x £165,000
x current value of £1 for 95 years at 5% = 0.00971
- Calculating the marriage value
The law says that if more than 80 years are left on the current lease, the marriage value will be zero.
Possible price of the new lease = £2,207
Effect of different yield rates
The yield rates the valuer uses directly affect the multipliers they use in the calculations, and different yield rates will result in different valuations. It is likely that the different perspectives of your and your landlord’s interests will lead to your valuers using different yield rates.