By Malcolm Martin
Over the last few years there has been much disquiet about the way the leasehold system has applied to both flats and houses. It was originally reformed in 1967 for houses, then in 1993 for flats and again in 2002 for both flats and houses. Nevertheless, it has been considered by many to still be too complicated and, especially by leaseholders, to be too expensive to extend their leases or purchase the freehold of their properties.
Consequently, the Government asked the Law Commission to consider the matter again and it did so by way of three reports published 21 July 2020. The Government has now issued its Response, dealing with two issues:
(i) The re-invigoration of the ‘commonhold’. This is a system widely used elsewhere in the world, whereby each flat owner not only owns their flat without a lease but is also, in effect, a part owner of the freehold of the entire block. Thus, when a flat owner wishes to sell their flat there is no lease to sell, and no freeholder’s permission needed. Instead they sell their flat together with their ‘share’ in the freehold of the building direct to their purchaser.
Since this is not likely to have a major effect in Dulwich for at least two or three years (and then probably only on smaller blocks of flats or new blocks of flats). I will go no further on this aspect in this article.
(ii) The complexity and cost of obtaining a new extended lease or freehold.
At present (for flats and ‘high value’ houses) there are three elements that contribute to the purchase price of a new extended lease or freehold with all figures being calculated at the ‘valuation date’. (This date is normally the date when the leaseholder(s) inform the freeholder that they wish to extend their lease or buy the freehold.)
The three elements are:
1. The current capital value of the annual ground rent. This is a ‘present value’ or ‘discounted cash flow’ calculation and is relatively easy to carry out. Where the ground rent is minor (eg £25 pa) this is a small component of the total cost payable. But where it is a significant sum (eg £250 pa, doubling every 20 or 25 years) and the current lease has more than 80 years unexpired, it can be the largest component of the price payable. Whilst the ground rent is fixed by the lease, there can be an argument over the rate of interest that is used to obtain the current capital value.
The Government here propose two variations:
(a) for the purpose of the calculation to cap the ‘ground rent’ at 0.1% of the freehold value of the flat. Whilst this may, at first sight, appear significant it is unlikely to have anything more than a minor impact on price payable for flats in Dulwich.
This is because:
(i) it will have no impact on those flats where the ground rent is nominal (eg £25 pa); and
(ii) where, for example, a flat worth £500,000 has a ground rent of £250 pa doubling every 25 years, the 0.1% of capital value is £500 pa. But that level would only have been breached at the end of 50 years, and due to the effects of time on these calculations, the total reduction in price at the valuation date is not likely to be significant in most cases. Where it will have a significant effect is on those leases where the ground rent doubles every 10 years. The second variation proposed by the Government in this part of the calculation is to prescribe the rates of interest that are to be used. The effect this will have on the final price to be paid will depend upon the prescribed rates (although where ground rent is minimal this will have minimal effect on the final price). The prescribed rates are said to be at ‘market value’. Since, however, the rate of interest used in this part of the calculation is already meant to be at ‘market value’ this aspect may have no significant effect on the price to be paid but will just reduce the time taken to agree that final figure.
2. The ‘present value’ of the property.
Under the current leasehold system, the property is meant to return to the freeholder (although there are statutory limitations on that). Thus the freeholder is said to get back the property worth, say, £500,000 at today’s figures. However, during the lifetime of the lease that £500,000 may reasonably be expected to increase. (One only has to look at property prices in Dulwich over the last 50 years to see this.) The question that the valuer has to answer is:
‘what price would someone pay now in order to get an asset at the end of the lease, the value of which at that date is unknown but which is worth £500,000 now?’.
That part of the calculation is carried out by taking a ‘present value’ based on the current value of the property (here £500,000) and using a discount rate of (normally) 5% for the number of years left on the lease. This 5% is meant to reflect the market rate for such a purchase and is made up of such elements as the cost of money, the expected long-term rate of property price increases, the illiquidity of buying property, and the risk of getting it all wrong. (The 5% was determined by the Lands Tribunal some time back in a case known as ‘Sportelli’ and is now generally applied throughout England and Wales.)
The Government proposal here is to prescribe a ‘market rate’. If it is higher than the Sportelli ‘market rate’ then the price of new extended leases and freeholds will decrease; if it is lower, then those prices will increase. There is no indication yet how the Government will actually determine this rate; or how and when it will be reviewed. It is feasible that it will be different for different areas eg 5% for Prime Central London (ie Westminster and Kensington & Chelsea); 6% for Greater London, 7% outside Greater London, but no details are known - and probably not yet decided.
3. ‘Marriage Value’
This is where the Government’s proposals will have the greatest effect, but only for those properties with less than 80 years unexpired, as ‘Marriage Value’ is only currently payable on those properties. ‘Marriage Value’ is calculated by ascertaining the total value of the freeholder’s and leaseholder’s interests after the transaction is done and deducting from that the total value of the freeholder’s and leaseholder’s interests before the transaction is done.
The difference between these two is called the ‘Marriage Value’ (ie the additional value brought about by the ‘marriage’ of the leaseholder’s and freeholder’s interests). Of that, 50% is payable by the leaseholder to the freeholder. This can be a substantial sum. So, for example, for a flat with about 40 years or so to run in Dulwich where a premium might be in the region of £100,000 or so, one might at present reasonably expect the 50% Marriage Value element payable to the freeholder to be in the region of one third (give or take). Thus, if the Government follow through with this proposal the future savings for leaseholders could be significant, running into thousands or tens of thousands per flat or house.
There is, however, one fly in this ointment. That is, it has been suggested that the removal of this 50% of Marriage Value payment could be open to a challenge under Human Rights legislation This is as it would be considered, by freeholders, as ‘deprivation of [their] possessions’ without adequate compensation”. In the view of the writer (but I am not a lawyer!!) any such challenge will, ultimately, fail. This is because regulating the issue of housing between the competing interests of freeholders and leaseholders is dealing with a matter of social injustice in the public interest. This aspect was previously decided by the European Court of Human Rights in James v UK (1988) with regard to the Leasehold Reform Act 1967. In that case the Court held that non-payment of any ‘marriage value’ (there called ‘merger value’) was not a breach of the freeholders’ human rights - essentially because “Parliament’s belief in the existence of a social injustice was not such as could be characterised as manifestly unreasonable” Since this case related to high value houses in Belgravia, I find it hard to believe the same principles would not be applied by the Courts to flats and houses outside Belgravia.
The more interesting aspect, especially from the point of view of the Dulwich Property market is that I expect the value of those (relatively few) flats with less than 80 years left on the lease (known as short leases’) to start to rise (gradually) when compared to the prices of similar flats where new leases have already been granted (known as long leases’). This will be in line with increases in expectation that this legislation will be passed, and so the ‘50% marriage value’ no longer be payable. And, as the value of those ‘short-leases’ increases in comparison to the ‘long lease’ flats, so the difference between the two will start to decrease and so the actual ‘50% Marriage Value’ will also decrease. This will then eventually impact on the price payable for new extended leases, which in turn will further increase the value of the ‘short leases’ compared to the ‘long leases’. Indeed, whilst writing this article I have already received the first circular email seeking to buy ‘short lease flats’.
There are other aspects of the Governments Response - that new extended leases will be for 990 years, subject to breaks for redevelopment; that new leases will always be at nil ground rent and for certain ‘low value’ houses (which applies to virtually all houses in Dulwich) will still have a discounted form of valuation if they have not already purchased their freehold. But I think that is sufficient for this article.
Malcolm Martin FRICS FNAEA
Malcolm Martin is a chartered surveyor who specializes in leasehold reform matters, commercial rent reviews and lease renewals and niche propert investment. Previously a partner in Harvey & Wheeler before branching off on his own, he has dealt with leasehold reform matters throughout Dulwich, Prime Central London and elsewhere in England for the last 40+ years.