Collective Enfranchisement: Costing
The most difficult elements of the process of collective enfranchisement is working out what the leaseholders should pay and how the freeholder is compensated for his loss. Another question is where is the funding going to come from when not all of the qualifying leaseholders wish to take part in the process and others are simply not invited?
Some banks will provide finance for this specific purpose and there are also companies offering ‘white knight’ funding in exchange for shares in the company. If these are to be considered however they must be thoroughly investigated before commencing the claim and no written contracts for third-party funding (except by way of a loan) should be entered into before an exchange of contracts.
The following example has been sourced from the LEASE website.
A block of 10 flats with 68 unexpired years remaining each have a ground rent of £50 per year. The individual market value of each flat with its existing lease is £150,000.
The total ground rent for the block is £500 p/a, which is 10 x £50. This figure is then multiplied by what is known as the Years Purchase, a multiplier taken from valuation tables or sometimes calculated by the valuer. To obtain this figure the most important part of the calculation is the assumed yield percentage and it is this that is likely to cause the most disputes between the valuers of both sides. Valuers will scrutinise local freehold auctions, looking at the unexpired terms and ground rents paid in the open market and will be able to calculate the assumed yield percentage in reverse from the evidence. The valuers will also need to be aware of the individual circumstances of the sale because the base information available from the auction results may not always provide completely accurate evidence on which other calculations need to be based.
So if the yield is taken as 8%, the Years Purchase figure is then looked up in the tables where 68 unexpired years at 8% is 12.433. £500 for ground rent is then multiplied by 12. 433 which equals £6,216. This is the estimated price a property investor would be prepared to pay today for a fixed income of £500 p/a for the next 68 years to produce a yield of 8%.
Reversion – Vacant Possession
At the end of the lease the flat becomes the property of the landlord who would expect to sell or re-let it. Vacant possession is the price a buyer in the open market would be prepared to pay today for the right to recover vacant possession of the flat when its current term expires. Therefore the current value of the flats is £150,000 x 10 flats = £1,500,000 (the leaseholders present interest).
IMPROVEMENTS TO THE PROPERTY
Where the leaseholder has made improvements to the flat at his/her expense (and with the landlords consent) which could affect its value, these improvements must, at the valuation date, be disregarded for the purposes of the valuation. This also applies to the leaseholders predecessors in title.
The object of this is to ensure that the leaseholder does not pay twice for improvements made to the property.
If the improvements are substantial the valuer will have to calculate the additional value they give to the flat but not what they cost.This must then be discounted from the estimated present value of the flat – in effect the valuer has to assess the unimproved value of the flat.
Note: This is potentially difficult area in that redecoration for example, could be deemed as repairing obligations under the lease term and will therefore not be disregarded.
In this example the assumption is that the improvement could produce an increase in the market value of each flat of around 10%. Therefore £165,000 x 10 = £1,650,000 so what is the promise of the future £1,650,000 worth today?
Again a multiplier is taken from the tables to provide an investment value and in this part of the valuation, the multiplier is the Present Value of £1. Taken at the same yield rate of 8% and deferred for 68 years is 0.00534. £1,650,000 x 0.00534 = £8,811
The investment value of the freehold (the freeholder’s interest) – is therefore represented by the sum of the values of the term and the reversion:
£6,216 + £8,811 = £15,027 – the sum that the interest is likely to achieve in an open market sale.
Note: If there is an intermediate lease such as a headlease in existence this also needs to be taken into consideration as it will cease to exist and the headlessee must also be compensated for his loss.
The legislation states that if a lease is held by a participating member of collective enfranchisement where the unexpired term exceeds 80 years at the valuation date, then no marriage value is payable.
Taking the figures from the previous example above, the improved value of the property is £1,650,000. The leaseholders present interest of £1,500,000 subtracted and from that figure, the freeholders interest of £15,027 is subtracted leaving a marriage value of £134,973. The 50/50 split between the freeholder and the enfranchising leaseholders, means the leaseholders have to pay half, which is £67,486 in addition to the freeholder’s interest. This example shows that the marriage value can considerably exceed the value of the freeholder’s interest. Its calculation is dependent upon the estimated increase in value of the flats and so the lower the increase 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, flat values will be affected.
The longer the current lease the lower the latent marriage value may be, until eventually it becomes negligible.
Note: In a Collective Enfranchisement action marriage value is only chargeable in respect of the flats of the participating leaseholders and the example above assumes all leaseholders participating for the sake of simplicity.
Again, using the above examples, and assuming there are no extra costs arising from additional freeholders’ interests or injurious affections, the potential valuation of the building would be the following:
- Freeholders interest of £15,027
- Marriage Value x 50% of £67,486
- Possible purchase price of £82,513 or £8,250 per flat
So, in essence marriage value is the value of the flats with a long lease, minus their present unimproved value in a ‘no Act world, minus the capitalisation of the ground rent and the reversionary value and all added together and divided by 2.
In some cases the leaseholders’ immediate landlord will not be the competent landlord for the enfranchisement process but an intermediate landlord who’s lease might also be only a few days superior to that of other leaseholders so it will shortly be ending. In this situation there is either no reversionary value or the amount is so small that it can be disregarded. If it is regarded then the value of the reversion will represent the diminution in the competent 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 landlords.
Marriage value (if applicable) 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 divided by 1500 = £2,790
The freeholder – £6,750 x 880 divided by 1500 = £3,960
Therefore the division of the leaseholders ‘premium between the landlords is:
Intermediate Landlord – diminution in interest of £620
Share of marriage value of £2,790 + £620 = £3,410
Freeholder – diminution in interest of £880
Share of marriage value of £3,960 +£880 = £4,840
Total Premium = £8,250
The next stage of the process is that of the serving of the initial leaseholder notice and the landlord counter notice which can be read here.