Mark Chick Exclusive! What Is Deferment Rate?
Mark Chick is a property expert, specialist leasehold solicitor and a Partner at Bishop & Sewell LLP. He is also a Director of the Association of Leasehold Enfranchisement Practitioners (ALEP) Here, Mark has written an exclusive for Leasehold Life where he focuses on a key element of the valuation calculation used to work out the cost of extending a lease or purchasing the freehold, that of deferment rate.
Part of the valuation calculation to work out what the premium to extend your lease or to purchase the freehold will be requires a calculation of the value of what is called the “reversion”, i.e. the value to an investor today of the right to possession of the flat in the future when the lease runs out.
In simple terms, the valuation question is ‘how much would an investor pay now to have possession at the end of the lease?’
Put another way, this could be phrased as the question ‘how much would someone put on deposit in a bank now, so that in X years’ time, it is equal to the value of the flat?’
The money put on deposit will increase with interest (compound rate) so the amount to be laid down now, will depend on the rate of interest as well as for the length of time (until the lease expires).
In order to work out what the answer to this question the valuer will refer to a rate of interest and this is what is known as the ‘deferment rate’.
So the deferment rate is the percentage rate used by a valuer to calculate the ‘deferred’ lump sum value of the flat.
A worked example may help. So let’s say that a flat is worth £1m ‐ and has a lease of 50 years remaining. The question is, ‘what would an investor pay today to receive vacant possession of the flat in 50 years time when the lease runs out?’
Let us assume for current purposes that the adjusted capital value of the flat is £1M (in reality the valuer needs to take into account deductions for any allowable improvements carried out by the tenant). This then needs to be decreased over the remainder of the lease term by using the chosen deferment rate on a compounded basis.
So, for instance, in the example mentioned above, an adjusted capital value of £1m, deferred at the rate of 5% p.a. produces a figure of £87,204. However, if the rate chosen were 5.25% then the figure is £77,427.
As can be seen, increasing the deferment rate reduces the value of the reversion (the value of the equivalent the sum that has to be put on deposit in the bank in the compensation calculation) and therefore reduces the amount that the tenant has to pay.
It is possible to argue about the adjusted capital value of the flat at some length and (to a certain extent less so after the decision in Voyvoda) about the applicable deferment rate, which is generally accepted to be around 5% following the decision in Sportelli.
However, at present a deferment rate of 5% is generally accepted as the “norm” taking in to account the likely growth rate in the capital value of the flat.