Lease extensions – the variables

einsteen sheep and formula

The Variables are not, as far as I know, an old rock band from the seventies – if they were, I am certain Johnnie Walker would be playing them. I’ve already listed most of them in the previous article but here again are the ‘band’ members:

  • ground rent yield rate

  • discount/deferment rate for the reversion value

  • “no Act” discount

  • schedule 10 rights allowance (discount)

  • freehold differential

  • value of the existing lease

  • value of the extended lease

Mere mortals like you and me (or even I) do not get to determine these variables, but it is good to know what they are and what they do.

If you are hoping for simple and clear bullet points, I caution you that this is about the £leasehold caper. Complexity means profit.

We already know that the 1993 Act offers the freeholder, by any view, generous financial protection from the outrageous requirement of having to grant a 90 year lease extension on top of 99 years (or 125 years, but I deliberately point out the common paltry starting term).

The premium comprises: capitalising the remaining ground rent to a present value so that the freeholder does not lose not a penny; calculating the freehold reversion value; and finally a half cut of the marriage value if the lease is 80 years or less.

Ground Rent Yield Rate

The important thing to note about the ground rent yield rate is that the higher the rate, the lower the premium.

Beyond that there is little to say. The ground rent has the advantage or disadvantage of being contractually fixed. An important member of the Variables band but not the lead singer in so far as variables go.

Discount/Deferment Rate for the Reversion Value

Again, the important thing to note about the discount/deferment rate for the reversion value (RV) is that the higher the rate, the lower the premium. No surprise that the freeholder wants the lowest rate.

I will spare myself trying to unravel the Court of Appeal Sportelli 5% fixed rate caper for Prime Central London that raged for a few years across the whole of the Queen’s Realm but seems to have been tempered by a more recent Birmingham appeal in Kelton Court that got the DR up to 6% outside PCL. When I come to the formula I will use an Upper tribunal case that settled on 5.5%.

The Sportelli 5% rate seems to have derived from mathematics (but I still fear theology played a part somewhere):-

RFR (Risk free rate) @ 2.25% Less RGR (Real Growth Rate) @ 2.00%

=0.25%

Plus (RP) Risk Premium @ 4.50% & Extra risk for flats @ 0.25%

= DR (Deferment Rate) @ 5.00%

Sportelli established the principle that the management of flats compared to houses was more complex and warranted a 0.25% addition to the deferment rate. As far as I know a block of two flats would have the same complexity of management as one hundred. Mind you, I fear some agents would find one flat complex to manage.

“No Act” discount

The important thing to note about this variable is that the higher the rate, the higher the marriage value, and therefore the more you pay the freeholder.

Here is a great article in the New Law Journal from 2008 titled “Sportelli: goodbye real world”, 24 April 2008, which also covers the No Act World saying this:-

The requirement that in valuing the reversion the tenant’s rights under LRHUDA 1993 are to be excluded mutated by degrees into the “no Act world”, something Parliament neither intended nor legislated for.

I am not qualified to comment. At least not in a legal sense. However, as a mere layperson leaseholder I find the ‘No Act world’ quite a fishy sort of caper. It introduces theology front and centre to what is supposed to be a legal process, and more importantly has the consequence of reducing the existing lease valuation – even if it is a real world valuation – and thereby hiking the marriage value.

Worse, this “benefit of the Act” artificial assumption apparently grows more beneficial as the lease gets shorter, so the discount has to be bigger.

That is precisely what the Upper Tribunal said in para 31 of Contactreal Limited and Ms Hannah M Smith, [2017] UKUT 0178 (LC).

Think about this. The creation of a right to enfranchise and to extend the lease is a ‘beyond doubt’ benefit per the courts and is therefore reflected in the real world value of the lease and must be banished for the theological world of the marriage value calculation.

Is it just me that wonders:

(a) how can the benefit grow just because the lease falls?

(b) if the benefit exists by virtue of an Act, surely it exists whatever the term of the lease?

(c) surely it cancels itself out if the new lease has the same benefit as the old lease?

The fact that the ‘artificial assumption’ is applied only when calculating marriage value is a matter of arbitrary human intervention, not a divine ethical imperative. Isn’t theology meant to have a basis in something higher than grubby profit motive gotchas?

Whatever the inspiration, it is a lucrative caper. Not only does the decreasing term inflate the relativity of the freehold reversion, it also increases the marriage value by an additional ‘No Act’ discount.

This discount seems to be one of those Schedule 13, s3(4) “hereby declares” other matters that leave the door open for new assumptions.

The best part about this discount is that it is variable. Here are some figures from previous tribunal cases that may or may not be reliable in future ones:-

Term unexpired

Act rights Deduction

57.68 years

5.5%

37.7 years

10%

23 years

20%

11.28 years

20%

17.8 years

25%

18.7 years

15%

44 years

7.5%

67.4 years

3.5%

68.65%

3.5%

Schedule 10 rights allowance (discount)

It appears that this variable discount must be claimed by the leaseholder. The others that benefit the landlord seem helpfully to be addressed automatically by the tribunal. This one addresses the ‘risk’ that the that the landlord might not obtain vacant possession upon expiry of the lease because of the possibility the tenant might remain in possession under an assured tenancy under Schedule 10 to the Local Government and Housing Act 1989

Lease-advice.org provides an article on the rights a leaseholder has when their lease expires.

I confess I have no knowledge of how this right operates in practice, and would hope nobody lets a lease expire to find out. It only goes to show how tortuous the lease extension process is that you need to submit for this allowance. Nevertheless, it is a nice counter balance to the next variable “the freehold differential”, as seen in Upper Tribunal case Contactreal Limited and Ms Hannah M Smith, [2017] UKUT 0178 (LC).

In this appeal heard in May 2017, the landlord got a 1% freehold differential added to the new lease value, but the UT then deducted 2.5% for the leaseholder’s Schedule 10 allowance. The landlord sought to block the Schedule 10 discount on the grounds that “there is a certain or very strong likelihood that at the end of 67 years the property will be developed by the landlord.” … “the tenant will have no rights to stay on if the landlord intends to redevelop the site.”(56).

This stuff gets obscure very quickly. The UT said:

57. …The existing lease of Flat 23 was a long lease at a low rent granted on 20 December 1984. As such it is a tenancy to which section 186(3) of the Local Government and Housing Act 1989 applies and which is defined under paragraph 1(6) of Schedule 10 to that Act as a “former 1954 Act tenancy”.

58. The redevelopment ground upon which a landlord may rely in claiming to resume possession at the term date of the tenancy is contained in paragraph 5(1)(a) of Schedule 10 to the 1989 Act which in turn refers to ground 6 of Schedule 2 to the Housing Act 1988. But paragraph 5(2) of Schedule 10 states that the said ground 6 may not be specified in a landlord’s notice to resume possession if the tenancy is, as here, a former 1954 Act tenancy. Paragraph 5(1)(b) of Schedule 10 is also a redevelopment ground but paragraph 5(4) provides that this may not be specified as a ground to resume possession unless the landlord is a body to which section 28 of the Leasehold Reform Act 1967 applies which is not the case here.”

So the landlord moved on to argue…

60. …in the alternative, that at the end of the original lease term the landlord would apply for an order for possession under section 61 and Schedule 14 of the 1993 Act and that consequently there would in practice be no risk of the tenant remaining in possession under an assured tenancy.”

The UT countered again:

62. I do not agree that section 61 is relevant where a new lease is yet to be granted under the 1993 Act.”

63. Section 61 is concerned with the landlord’s right to terminate the new lease on the grounds of redevelopment. That right has no effect on the value of the landlord’s existing interest which is to be valued on the basis that there are no rights to acquire a new lease. ...”

66. In Vignaud v Keepers and Governors of John Lyons Free Grammar School (1996) 71 P&CR 456 the Tribunal, His Honour Judge Rich, said at 459 in connection with a dispute about whether there should be a deduction for the tenant’s 1954 Act rights to a statutory tenancy:

“… It must be clearly understood that the proper deduction for this right must be a matter of evidence or argument. It is not a matter to be determined by convention or derived from the decisions of Tribunals on other evidence and other facts.”

The UT concluded:

68. Given the existing lease had an unexpired term of 67 years it was unlikely that a hypothetical purchaser would have made a significant deduction for Schedule 10 rights in the circumstances described and, in my opinion, a nominal discount of 2.5% would have been appropriate. I therefore determine the Schedule 10 allowance in this amount.”

On the other hand, in Elmbirch Properties Plc, [2017] UKUT 0314 (LC) decided on written representations in July 2017, the UT said:

“23. …it was not suggested in these cases that the tenant would take advantage of rights under Schedule 10 to the Local Government and Housing Act 1989.”

So no allowance was awarded to counter the 1% freehold differential in this case.

Freehold differential

As a layperson I find this variable somewhat vexing. Essentially the new lease is valued by a theological process and then 1% is added to allow for the freehold vacant possession value of the new lease at the end of its term.

My problem here is that the freeholder retains the freehold at all times. The leaseholder never possesses any freehold value. No more than under the existing lease.

In Contactreal Limited and Ms Hannah M Smith, the UT explained the issue:

70. It is generally recognised that there is a qualitative difference between freehold and leasehold tenure and that a leasehold, however long its term, is not as valuable as an equivalent freehold. The relativity of even the longest lease may approach 100% but will not reach it. This valuation principle is reflected in many Tribunal decisions and in Earl Cadogan v Erkman [2011] UKUT 90 (LC) the Tribunal set out an appropriate range of relativities at paragraph 98: “Leases with unexpired terms of 100 to 114 years – 98%; 115 to 129 years – 98.5% and above 130 years – 99%.

Having understood that “a leasehold, however long its term, is not as valuable as an equivalent freehold,” a layperson like myself might imagine that granting a lease extension would not involve any freehold value any different to the existing lease. Apparently this would be wrong. The top up must be added. I have yet to have this penny drop. It annoys me I cannot figure it out.

Value of the existing lease

The decision in Sloane Stanley Estate v Mundy [2016] UKUT 223 (LC) addressed the matter of the relative value of a flat with and without an extended lease.

The subject takes on a theological aspect as the assumption must be made that rights under the 1993 Act do not exist when you assess value.

It is necessary to list four key Mundy paragraphs:

“166. …the valuations required under schedule 13 to the 1993 Act relate to market value on the statutory hypotheses. When the parties attempt to negotiate the amount of a premium in accordance with schedule 13 and when the tribunal comes to determine a dispute as to the amount of such a premium, the relevant valuation date will generally be a date in the past. The parties and the tribunal must focus on the state of the market at that date. What matters is how the market performed at that date. If the market, for example, for leases with rights under the 1993 Act at that date was influenced by certain matters, then that influence must be taken into account. For example, if the market at a date in the past was influenced by a particular graph of relativity then that influence is a market circumstance which is to be taken into account. It is not open to a party when discussing the market at a date in the past to suggest that the market was badly informed or operating illogically or inappropriately in order to invite the tribunal to replace actual market forces with what are suggested to have been more logical or appropriate considerations.

“167. ...it is possible that the market might perform differently in the future from the way it has performed in the past. It is possible that in the future less weight will be given in the market to a particular graph or a new graph might emerge. If those new developments affect market behaviour then they must be taken into account when assessing market forces. It is conceivable that decisions of the tribunals might also influence valuers and in turn influence parties in the market. If that were to occur, then the changed market circumstances before a relevant valuation date must be taken into account when considering market value at that date.

“168. …in some (perhaps many) cases in the future, it is likely that there will have been a market transaction at around the valuation date in respect of the existing lease with rights under the 1993 Act. If the price paid for that market transaction was a true reflection of market value for that interest, then that market value will be a very useful starting point for determining the value of the existing lease without rights under the 1993 Act. It will normally be possible for an experienced valuer to express an independent opinion as to the amount of the deduction which would be appropriate to reflect the statutory hypothesis that the existing lease does not have rights under the 1993 Act.

“169. ...the more difficult cases in the future are likely to be those where there was no reliable market transaction concerning the existing lease with rights under the 1993 Act, at or near the valuation date. In such a case, valuers will need to consider adopting more than one approach. One possible method is to use the most reliable graph for determining the relative value of an existing lease without rights under the 1993 Act. Another method is to use a graph to determine the relative value of an existing lease with rights under the 1993 Act and then to make a deduction from that value to reflect the absence of those rights on the statutory hypothesis. When those methods throw up different figures, it will then be for the good sense of the experienced valuer to determine what figure best reflects the strengths and weaknesses of the two methods which have been used.

Para 167 reads suspiciously to this layperson like a self-fulfilling prophecy where the courts can decide what the real market does.

Para 168 leaves open the right of the court to judge whether a real world sale reflected the value of that flat – seeming to me to render the whole ‘comparables’ exercise pointless. The court gets to choose the comparables and to reject ones it does not like.

Para 169 in the end leaves the whole caper to a matter of judgement, not science. This is where the profit motive gets to play.

Meanwhile the leaseholder pays all the costs.

Value of the extended lease

The same principles apply as valuing the existing lease. The difference between the two values will be influenced by the theology of market relativity, not to be confused with Einstein’s mathematical proof of relativity.

Let us look at the valuation process in action:

Elmbirch Properties Plc, [2017] UKUT 0314 (LC)

In this UT case involving two flats, the first was 51 Humphrey Middlemore Drive. I use this case in working through the formula. Here I will delve into the valuations.

The FTT determined the premium and refused permission to appeal. The UT granted the right to the landlord.

No 51 was a 1980s ground floor one bed flat in Birmingham in a ‘complex’ of mainly 1 and 2 bed blocks. At the valuation date it was in good condition, with double glazed windows, a new bathroom and new kitchen.

At the date of valuation the lease had 68.62 years unexpired. The leaseholder proposed a premium of £5,880 and the landlord countered with £21,400. The FTT had settled on a premium of £8,997. To cut a long story short, the UT determined a premium of £13,136. The leaseholders had not participated in the appeal.

Even before getting into the theology, it must be noted that two expert courts reached premiums where the UT added 46% to the FTT’s figure. It makes the process seem more like a lottery?

The FTT decided the existing valuation at £99,000 and the extended valuation at £112,385. The FTT’s ‘relativity’ started at 92.84% for the existing versus extended lease with no freehold differential added to the extended lease. The FTT did not discount for the ‘No Act’ variable. The deferment rate was 5.5%.

The UT included the freehold differential at 1%, and followed Contactreal Limited and Ms Hannah M Smith, [2017] UKUT 0178 (LC) in setting the No Act discount at 3.5%.

The UT completely revisited the valuation evidence put to the FTT.

The landlord had referenced an asking price that had not completed and a sale from five years before the valuation date adjusted forward using the local land registry averages for flat sales. The landlord’s valuer (para 54) preferred to place weight on the adjusted sale of more than five years before the valuation date rather than use a graph to adjust existing lease value.

The UT opined:

“59. This review shows how thin the available evidence is. Good market evidence should always be preferred to graphs where it is available, but here that evidence is limited to a notably historic transaction adjusted by reference to a general index spanning five years, and a second “comparable” which is the evidential equivalent of Sherlock Holmes’ “dog in the night-time” in that nothing happened; unlike Holmes, however, we deduce little from it.”

The UT settled on an extended valuation of £117,000, added 1% for the freehold differential and used 81% relativity to set the short leasehold value at £95,500 without Act rights (i.e. 3.5% discounted).

But to avoid setting any precedent they said:

“63. Our conclusions in this unopposed appeal and on this limited evidence should not be relied upon as a precedent for relativity levels, or other adjustments, in other cases which should continue to be determined on the evidence adduced in those cases.

The difference between the FTT and UT in valuations before adjustments:

Valuations

FTT

UT

Existing lease:

£99,000

£95,500

Extended lease:

£112,385

£118,200

Relativity:

88%

81%

Premium:

£8,997

£13,136

Conclusions?

Personally, I read tribunal cases in amazement that nobody can come up with a clear cut method for flat lease extensions.

The 1993 Act predated the internet. Nowadays anybody can see the history of sales by postcode and use the land registry indices for local sales. The Bank of England and other provide widgets for checking the inflation rate between any two dates.

Is it beyond the wit of legislators to come up with an online calculator where the parties can both enter a valuation date, postcode, address and other data such as unexpired term, ground rent increments and so on, and have a premium calculated that has a reference number that is a binding result?

Whereas it is true that various agencies offer property valuations that range wildly because they take no account of leasehold (ironic given one Noble Lord’s confidence in the system), such a bespoke widget would take account of all variables.

Or perhaps the premiums would be banded in tables that the land registry can adjust as markets move?

Anything has to be better than this absurd, turgid, theological nonsense where the captive leaseholders pays all fees for such unreliable lottery results. On another day it must be feared that a different tribunal composition would make completely different judgments and mathematical mistakes.

I can’t think of anything comparable in ‘’normal’ life to this expensive farce.

In the next instalment I will delve into the maths.

One thought on “Lease extensions – the variables”

  1. excellent and thorough analysis; thanks for lifting the lid on this legal farce; lawyers are notoriously innumerate and it is beyond comprehension how those RPTS are still allowed to operate using these obscure rules

    Like

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s