Quiz - how well do you understand your lease?
Understand the key things you should know about your lease. If you are a purchaser, this can help make sure your solicitor has covered all of these points and explained them clearly to you.
This leaflet is not meant to describe or give a full interpretation of the law; only the courts can do that. Nor does it cover every case. If you are in any doubt about your rights and duties then seek specific advice.
Anyone considering enfranchising (buying) the freehold of their leasehold house will probably begin by asking ‘How much will it cost?’ The valuation process required by the law is complicated so it is often difficult to form a clear view of the price at the beginning of the process.
This advice note sets out to describe:
- The statutory bases for valuation
- The way in which the price is assessed
- The role of the professional adviser in the process
This note is not intended as a ‘do-it-yourself’ guide to valuing your own freehold. You should seek professional advice at the earliest possible stage.
The Leasehold Reform Act 1967 (the 1967 Act) gives leasehold tenants of houses the right to buy the freehold. The right to compulsorily purchase the freehold (and any intermediate leasehold interest) is termed enfranchisement. Some freeholders will sell the freehold without the need for a formal claim, but, whether a claim is made or not, the leaseholder should obtain professional advice to find out roughly what the whole process will cost.
Because the basic right has been extended over the years by various amendments made to the 1967 Act, the rules for calculating the price are somewhat complicated.
The two valuation methods
The 1967 Act provides two distinct bases for the valuation of houses under the Act. These are generally referred to by the relevant section of the 1967 Act, as follows:
Section 9 (1) – the house will be valued according to the original valuation basis, that is, the value of the site.
Section 9 (1A), 9 (1C) – the house will be valued according to the special valuation basis, that is, the value of the house, including a share of the marriage value.
The valuation method under which the house is to be valued is not a matter of choice by the landlord or the leaseholder but is determined by the qualification criteria.
- if the lease satisfies the original low rent test and the house satisfies the value limits, then it will be eligible under Section 9(1) and will be valued according to the original valuation basis.
- in all other cases, including cases where the original lease had been extended under the provisions of Section 14 of the 1967 Act, it will be valued according to the special valuation basis.
The special valuation basis of assessment generally means that the price is much higher than that which would be payable under the original valuation basis. It is therefore very important to establish under which basis the house is to be valued.
Under both sets of rules the law requires the freeholder’s interest to be valued as if it were being sold in the open market by a willing seller to a willing purchaser. The principles of the 1967 Act are not to provide a forced bargain for the leaseholder, but adequately to compensate the freeholder for the loss 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.
Where the freeholder and the claimant cannot settle the price by negotiation, a First-tier Tribunal (Property Chamber) can be asked to settle the matter. The Tribunal’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 prices proposed by either the claimant or the freeholder.
The process of enfranchisement is started by serving a formal notice of claim. Once you have served this notice, you will be liable to pay the freeholder’s reasonable costs in dealing with it so you should find out what the likely cost is before you begin the process. A valuation surveyor competent in the legislation and with a good knowledge of the local property market will be able to help you.
You will need professional advice to confirm your rights and the valuation method to be used.
You will therefore need to gather a certain amount of information. A professional adviser will be better able to help if he has the relevant information to hand. The following checklist should be useful.
Details of the lease
- The date of the lease, or the commencement date if this is different (this is the date of the original lease, not always the same as the date on which you acquired the lease).
- The amount of the original ground rent payable at the start of the lease, if any.
- The amount of any premium included in the lease.
All this information should be on the first page of the lease document itself. If you do not hold the lease, you will need to obtain a copy from your mortgagee (the bank, building society etc), your solicitor or whoever holds it. A copy of the lease may also be available from the Land Registry.
- You will need the rateable value of the house on the first day of the lease (if it had one), or 23rd March 1965, whichever is the later; and
- The rateable value on 31st March 1990.
You may be able to obtain this information from your local authority or water utility company , if you are not on a meter.
The Original Valuation Basis (site value)
The original reasoning behind the 1967 Act was that the freeholder owned the land but the leaseholder owned the house. So, at the end of the lease, the freeholder would be left with a vacant piece of land which he could let at a ‘modern ground rent’.
The reality is, of course, rather different but the principle remains the same: to assess today’s value of the land the house stands on in terms of the ground rent the landlord could receive, at today’s rates.
The 1967 Act provided an alternative approach to this based on the leaseholder’s statutory right to a new lease. The right is to an extension of 50 years, from the date of expiry of the present lease. The ground rent for the new lease would be assessed on the first day of the lease as a proportion of the value of the land, the site value, and would be a modern ground rent (a modern ground rent is usually a figure far in excess of the existing ground rent).
The valuation procedure will assume that the leaseholder takes up his right to the 50-year extension at the modern ground rent. Therefore the freeholder’s interest becomes the right to receive the rent and any increased rent on review during the term of the lease (‘the term’), followed by the right to receive a modern ground rent for 50 years (‘the first reversion’), followed by the right to vacant possession of the house at the end of the lease (‘the second reversion’). It is called the reversion because it is at the time when the house reverts to the freeholder.
The original valuation procedure can be illustrated by an example: assume a house with 28½ years presently left on the lease, a fixed annual ground rent of £6.25 and an estimated freehold vacant possession value of £160,000.
Calculating the term
The freehold interest in a house occupied by a leasehold tenant is an investment. The freeholder’s money is tied up in the ownership of the house and in return he receives a rent.
The rent, divided by the value of the interest, is called the yield. This is a similar concept to the interest received on a building society account. The rate of interest an investor receives on his money is also the yield. If building societies are offering accounts at 10% per annum, the account yields 10% on the money invested. Investors look at the property interest in much the same way and what they are prepared to pay for them depends upon the yield they are seeking. From his knowledge and experience of the investment market, the valuer will determine the yield the freeholder could expect to receive for the rent payable under the lease and, by multiplying the rent receivable by the yield for the remaining term of the lease (the ‘Years Purchase’, a figure which can be found from valuation tables), will calculate the value of the freeholder’s interest during the term of the lease: For this example the yield is assumed to be 6.5%.
Ground Rent £6.25 per annum
Years Purchase for 28½ years @ 6.5% (from tables) is 12.83
So, the term is £6.25 x 12.83 = £80
The calculation provides a figure representing compensation to the freeholder for his loss of the rental income over the remaining period of the lease. Therefore, £80 is taken as today’s value of the right to receive £6.25 a year for the next 28½ years. It is not correct just to multiply the ground rent by the remaining years of the term.
Calculating the first reversion
The next step will be to value the modern ground rent. The whole valuation is carried out at the date of claim and values are not projected forward in time. Therefore the valuer is looking for the value of the land on which the house stands at the date of the Notice of Claim. There is rarely any evidence available of sales of individual plots of land therefore the only way of deciding on the value of the land is to look at it as a percentage of the value of the house. The valuer will have to assess the value of the house on a freehold basis assuming there is vacant possession and, under this basis of valuation, that the house has been developed to its full potential.
Having valued the house, the valuer will then use his local knowledge and experience to determine what percentage of that value will be attributable to the cost of the land: the site value. Depending upon the location and nature of the house, the percentage is likely to be in the band 30% to 50%. Having arrived at a site value, he will then ‘decapitalise’ it, possibly using the same yield as for the ground rent, in order to arrive at the modern ground rent.
This rent is then valued as a future income, that is, the value of the site to the landlord is today’s right to receive the modern ground rent, but starting at a point in the future, in our example, in 28½ years time:
|Present freehold vacant possession value of the house||=||£160,000|
|Site value taken as 33⅓% of that value £160,000 x 33⅓%||=||£53,333|
|Modern ground rent taken as 5.5% of site value £53,333 x 5.5%||=||£2,933pa|
|Years Purchase for 50 years, @ 5.5% 16.932||=||£49,662|
|Purchase value of £1 in 28½ years @5.5%||=||0.2175|
|So the first reversion is £2,933 x 16.932 x 0.2175||=||£10,801|
Calculating the second reversion
In addition to capitalising the modern ground rent during the 50-year period, the value of the reversion at the end of this period will be calculated and added on to the formula to calculate the price.
This is known as the second reversion and is calculated using the standing house value; that is the value of the property in its existing form and on the basis that it has not been developed to its full potential. This may be lower than the value of the house used to calculate the first reversion.
Applying this to the figures above, the second reversion is calculated as follows:
Standing house value £114,000
|Purchase value of £1 in 78½ years @ 5.5%||0.015||£1,710|
The purchase price for the freehold is therefore the sum of the values of the term and the first and second reversion.
|£80 + £10,801 + £1,710||= £12,591 (say £12,600)|
Implications of leaseholder improvements on the valuation
The 1967 Act provides no statutory guidance as to whether or not the value of the leaseholder’s improvements should be included in the calculation under the original valuation basis (these are specifically excluded from the special valuation basis).
In the absence of such guidance, the inclusion of improvements may make a difference in the estimation of the vacant possession value of the house, from which the site value is assessed. The matter hinges on the assessing of a modern ground rent and the value of the land must be affected by what stands or could stand on it, that is, the value of an average house in the street, or a building appropriate to the area. It is important to understand, when assessing site value, that it is a matter of what could be put onto the site that is relevant, not what stands on it at present. That is, the house a developer would build on the site today, not what he built at the start of the lease.
For example, if all the neighbouring houses have back additions or conservatories but the subject house does not, it would be reasonable to assume that if a house was to be built on the site it would also have the same back addition or conservatory. The valuer has to take the actual or non-existent improvements into account when valuing the house for site value purposes.
Therefore, any improvements that have been carried out to the house should be taken into account in relation to what is reasonable for the area. For example, the improvements may be the installation of a bathroom and internal WC where none existed before. These would place the house in keeping with the average house in the street, assuming that they have also been brought up to the same standard. (Bear in mind the requirement for a modern ground rent.) In this case it would be quite legitimate to include the value of the tenant’s improvements in the valuation.
The only situation in which leaseholder’s improvements should not be included is where they make the property substantially better than the average.
The Special Valuation Basis (market value)
The alternative method of valuation is rather different and is based on the reality that the freeholder will gain possession of a house and not a cleared site. The method also recognises the leaseholder’s special interest in the purchase and this is applied as marriage value to be added to the open market value of the landlord’s interest when the long lease expires.
Marriage value is a concept used by valuers which describes the increase in value which is produced when two interests in the same property, formerly owned by different people, come into the ownership of one person. For example, a house with, say, a 60-year lease may have an open market value of £100,000, where the same house, in the same condition, might be worth £115,000 if it were freehold. So on purchase of the landlord’s interest in the house (the freehold), the value of the house would immediately increase from £100,000 to £115,000. Now, assuming the value of the landlord’s interest in the freehold is £3,000, then the tenant will, in expending £3,000, make a ‘profit’ of £12,000 from the uplift in value of the house. It is this ‘profit’ which is the marriage value and, in this case, the cost of purchasing the freehold would be £3,000 plus half of £12,000.
In the calculation of the marriage value, the leaseholder’s and freeholder’s valuers will rely on local knowledge and experience to assess the increase in value of the house arising from acquisition of the freehold.
The 1967 Act requires that the marriage value should be shared equally between the tenant and the freeholder. No marriage value is payable in cases where the unexpired period of the lease is more than 80 years.
Valuation by the special valuation basis can be illustrated by an example:
A house with an unexpired term of 65 years and a rent of £50 a year has a vacant possession value estimated at £120,000.
Calculating the term
As in the previous example, the future ground rent income is capitalised to produce a value, based on what an investor would be prepared to pay for it.
Ground rent £50 per annum
Years Purchase for 65 years @ 7% (from tables) is 14.11
So, £50 x 14.11 = £705
The yield rate used is 7%
although tribunals are less reluctant to consider higher yields in special valuation basis calculations. In this light it is worth saying a little more about the effect of varying the yield rate.
The valuer will estimate the assumed yield percentage from a close scrutiny of other transactions, particularly local freehold auction prices, calculating 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 an important element in valuation and one likely to be the subject of difference between the leaseholder’s and freeholder’s valuers.
It should be borne in mind, however, that present ground rents are generally low and so their capitalised values are not greatly affected in real terms by the yield rate multiplier. Depending on the length of lease, it is the reversionary value which will be subject to the greatest variations according to yield rates.
Calculating the reversion
Unlike the previous method, there is now no assumption that the lease will be extended by 50 years. So, on expiry of the lease, the freeholder will receive the house with vacant possession and will be able to realise its full value. It is therefore necessary to estimate its freehold vacant possession value, deferred until the end of the existing lease.
It is in the nature of a leasehold tenancy for the value of the lease to diminish as the lease nears expiration. Therefore, it can reasonably be assumed that, on acquisition of the freehold, the house will be worth more than it is on its present lease. How much more will be heavily dependent upon the unexpired length of the lease at the time of purchase and its general saleability; there are no hard and fast rules for assessing the new value. It is this that the valuer will have to establish: the present leasehold value of the house and the potential freehold value, based on his research into sales of local comparable properties.
For the purpose of the example, it is assumed that the acquisition of the freehold will produce an increase in value of 10%.
|Improved value £120,000 + 10%||= £132,000|
A valuer may also account for the leaseholder’s right to occupy the property after the lease has ended. The law provides that when a long lease expires the leaseholder can continue to occupy the property, under an assured tenancy, paying a market rent. This right can in some cases reduce the value of the freehold interest. This is ignored for the purpose of this example.
As with the previous example, the full present value of the house is deferred to produce an investment value – what is the promise of £132,000 in 65 years’ time worth today? The multiplier, taken from tables, is applied at the same yield rate used for capitalising the rental income:
|Present value £1 deferred 65 years @ 7%||= 0.0123|
|So, £132,000 x .0123||= £1,624|
The investment value of the freehold
The investment value of the freehold – the freeholder’s interest – is represented by the sum of the values of the term and the value of the reversion.
|£705 + £1,624||= £2,329|
and is the sum that the interest is likely to achieve in an open market sale.
Calculating the marriage value
As described earlier, marriage value is the increase in the value of the property following the completion of the enfranchisement or a lease extension. This reflects the additional market value of a longer lease or the freehold. In that this potential ‘profit’ only arises from the freeholder’s compulsion to sell, the legislation requires that it be shared equally between the parties.
Taking the figures from the previous example above:
the improved value of the property is £132,000
from this is subtracted the leaseholder’s present interest £120,000
the freeholder’s interest £2,329
In this case the marriage value is £9,671
With the 50:50 split between the freeholder and the enfranchising leaseholder, the leaseholder would have to pay half this figure – £4,835 – in addition to the value of 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 relative values of the house with its present lease and the house after acquisition of the freehold and, clearly, the lower the gap between these values, the lower 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, house values will be affected.
As the length of the current lease increases so the difference between its value and the freehold value becomes smaller until eventually the marriage value disappears.
Exclusion of leaseholder’s improvements
In calculations under the special valuation basis, any additional value in the property arising from improvements by the leaseholder should be ignored; the leaseholder should not pay any additional premium in respect of value added by improvements carried out at his own expense, or that of a predecessor to the lease.
Completing the valuation
The purchase price for the freehold is, therefore, the sum of the values of the freeholder’s interest and the agreed share of the marriage value:
landlord’s interest £2,329
marriage value x 50% £4,835
Total = £7,164
It will be obvious from the example where there are likely to be differences between the parties, notably the potential increase in the value of the house after enfranchisement and the proportional division of the marriage value.
The role of the valuation surveyor
Given the complexity of the leasehold reform legislation, it is important to have competent professional advice. A valuer can offer assistance in the following areas:
- To advise on whether the leaseholder qualifies under the Leasehold Reform Act 1967 and which basis for valuation would be used
- to carry out the valuation
- to advise on the possible purchase price, based on experience and preparation of ‘best and worst case’ valuations
- to conduct negotiations with the freeholder on behalf of the leaseholder
- to provide expert evidence at the First-tier Tribunal (Property Chamber)
You would be prudent to consult a valuer who is a qualified surveyor – a fellow or associate of the Royal Institution of Chartered Surveyors.
Not all surveying practices specialise in this kind of work and you should make careful enquiries relating to the practice’s experience of the legislation before proceeding. Advice on local practices can be obtained from the professional body referred to above.
- Qualification Requirements
To be a qualifying tenant you must:
- have a long lease or
- have the lease of the whole house
- have owned the lease for two years
* Where the tenant of the whole house is a head-lessee of a house divided into flats let on long leases then the tenant (head-lessee) does not qualify unless he lives in a flat in the house and has done so for two years (or periods amounting to two years in the last ten).
- Long leases
A long lease is:
- a lease of a term of years absolute in excess of 21 years* from the date of grant (the lease runs from the date of grant not from the commencement date of the term).
- a shorter lease which contains a clause providing a right of perpetual renewal.
- a shared ownership lease where the leasehold tenant’s share is 100%. However, such a lease does not qualify for enfranchisement under the 1967 Act if it includes a provision for the freehold to be transferred on the purchase of the remaining share in the property. Other exemptions apply if the house was provided for the elderly or within a designated area referred to as a protected area.
*The present unexpired term is not relevant; qualification is governed by the original term of the lease when first granted.
How to establish which valuation method should be used
Most houses qualifying under the legislation will be valued according to the Special Valuation Basis, including the marriage value.
For the house to be eligible for the Original Valuation Basis (site value) it will need to meet the following qualifications, based on rent and values, plus the further value limit:
- The original low rent test
- Leases granted before 1 April 1990 – the annual ground rent, payable on the date of service of the Tenant’s Notice and for the previous two years qualifying period, must be less than two-thirds of the rateable value of the house on the latest of these dates:
23 March 1965, or
the first day the house appeared in the valuation list, or
the first day of your lease
but if the lease was granted between 1 September 1939 and 31 March 1963 the rent must also be less than two-thirds of the letting value. It is up to your landlord to show if this test applies.
- Leases granted on or after 1 April 1990 – the rent on the day you serve your notice on the landlord must be equal to or less than £1,000 in Greater London or £250 elsewhere.
- Leases granted on or after 7 September 2009 – in England only – the low rent test has been abolished so the lease will be treated as if at a low rent for the purposes of establishing the appropriate valuation method (your local authority or water board may be able to provide the rateable value details but only a valuation surveyor can advise you on letting values).
- Value limits
These are dependent upon when your lease was granted.
- if your lease was granted on or before 18 February 1966:
if your house first appeared in the rating list before 1 April 1973, its rateable value on 23 March 1965, or on the first date it appeared in the rating list, if later, must not have been more than £400 in Greater London or £200 elsewhere;
or: if the house first appeared in the rating list on or after 1 April 1973: its rateable value on the first day it appeared on the list must not have been more than £1,500 in Greater London or £750 elsewhere.
- if your lease was granted after 18 February 1966 but before 1 April 1990:
if your house first appeared in the rating list before 1 April 1973, its rateable value on 23 March 1965, or on the first day it appeared on the rating list, if later, must not have been more than £400 in Greater London or £200 elsewhere.
or: if your house first appeared in the rating list on or after 1 April 1973 its rateable value on the first day it appeared on this list must not have been more than £1,000 in Greater London or £500 elsewhere.
- if your lease was granted on or after 1 April 1990 then you must first work out the value of R using the following formula:
R = P x I / 1-(1+I)-T
P is the purchase price paid when the lease was granted (if none was paid, P is 0)
I is 0.06
T is the number of years granted by the lease
R must not be greater than £25,000.
Further value limits
Where the house satisfies all of the above qualifications it will qualify under Section 9(1), but must meet the following further limits to be valued by the Original Valuation Basis:
- if your house had a rateable value on 31st March 1990, the rateable value must have been £1,000 or less in Greater London or £500 elsewhere.
- if your house did not have a rateable value on 31st March 1990, the value must be no more than £16,333 for R, using the formula above.