Compensation to the Freeholder and the Valuation
The most difficult elements of the process of collective enfranchisement is working out a) what the leaseholders should pay and b) how the freeholder is to be compensated for his loss of ground rent which although paid for by leaseholders it is actually used by freeholders as an an investment vehicle.
To show how this is worked out, the following example is sourced from the LEASE website:
- A block of 10 flats with 68 unexpired years left on it each have a ground rent of £50 per year. The individual market value of each flat with its existing lease is £150,00
- 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 this 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 give 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 ready 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 either 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
From establishing that the current value of the flats is £150,000 x 10 flats = £1,500,000 (the leaseholders present interest) what happens if the current leaseholder has made improvements to the flat at their own expense (with the landlords consent) or improvements carried out by the predecessors in title, which could affect the value?
At the valuation date the improvements must be disregarded for the purpose of the valuation in order for the leaseholder not to pay twice. This is usually a difficult area in that some improvements are easy to identify but on the other hand, expenditure on a property in terms of decoration and renewal of services could be deemed as repairing obligations under the terms of the lease rather than improvements and will therefore not be disregarded.
If the improvements are substantial then the valuer will calculate the additional value they give to the flat but not the actual cost. This additional value must then be discounted from the estimated present value of the flat so the valuer is actually assessing the unimproved value of the flat.
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 so £6,216 + £8,811 = £15,027 is the sum that the interest is likely to achieve in an open market sale.
Note: If there is an intermediate lease such as a head-lease in existence this also needs to be taken into consideration as it will cease to exist and the head-lessee 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. However if unexpired term is less than 80 years unexpired then taking the improved value of the property which is £1,650,000, the leaseholders present interest of £1,500,000 is 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.
Assuming there are no extra costs arising from additional freeholders’ interests or injurious affections, (this relates to a compulsory purchase situation where only part of something is taken) 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
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.
So, in essence marriage value is the following:
- 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;
- All added together and divided by 2.
It may be however that the leaseholders immediate landlord will not be the competent landlord for the enfranchisement process but will be an intermediate landlord who may have a lease that is 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 however then the value of the reversion will represent the reduction 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 reduction 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
This makes the leaseholders ‘premium’ between the landlords of:
- 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