Leasehold Reforms: How it Started / How it's Going14 July 2021
On 9 January 2020, the Law Commission published their review on the options for reforming leasehold valuation: Leasehold home ownership: buying your freehold or extending your lease – Report on options to reduce the price payable. A final report on reforming all aspects of leasehold enfranchisement was published on 21 July 2020 entitled Leasehold homeownership: buying your freehold or extending your lease. A summary report was published alongside.
On 11 January 2021, Robert Jenrick, the Secretary of State, said leasehold reform would be tackled through two pieces of legislation.
The Leasehold Reform (Ground Rent) Bill was introduced in the House of Lords on 12 May 2021. This Bill will fulfil the commitment to “set future ground rents to zero.” The provisions will apply to leasehold retirement properties, but not before 1 April 2023.
Key valuation aspects affected by the second, future piece of legislation will be:
- Abolition of marriage value. This is a sum payable where a lease has less than 80 years unexpired. It is considered for such properties that the increase in property value following lease extension/freehold purchase exceeds the amount otherwise payable for exercising such rights. Marriage value hence represents the sharing of the increase of value in a property due to lease extension or freehold acquisition with the freeholder. The sums involved can be very significant and often a large part of the overall premium payable by the leaseholder.
- Capping of the treatment of ground rents at 0.1% of the freehold value. This means that any ground rent due under the lease, exceeding 0.1% of property freehold value at the point of valuation, will be ignored for the purposes of calculating the premium payable for lease extension/freehold purchase.
- Prescription of rates used for the calculations at market value. When valuing a lease extension or freehold purchase, future ground rent due under the lease is capitalised using a yield rate (the capitalisation rate) to produce a sum in today's money. Similarly, the future value of the property reverting to the freeholder at the end of the lease is assessed using a yield rate known as the deferment rate. The lower the rates, the more punitive for the leaseholder. This reform will fix the relevant rates and remove them as a source of debate between valuers.
- Introduction of 990 year lease extensions without any limitation on the numbers of such extensions allowable for any given property. Currently a statutory lease extension provides 90 years in addition to the existing term and only one extension is allowed per property.
- Removal of development value by providing leaseholders with the option to voluntarily agree to a restriction on future development of their property. During freehold purchase leaseholders often have to pay more for potential development opportunities - such as conversion of a loft space retained by the freeholder - even if they have no intention of carrying out any such development. The sums involved can be significant and this reform will allow leaseholders to choose not to carry out any development, and hence not to pay additional sums in this regard. Note that whilst this reform was originally announced by Robert Jenrick, it is not listed in the 18 May update.
This future legislation will require at least a year for the preparation of primary legislation for consideration by The House of Lords.
The proposed reforms have been taken as bad news for freeholders, and correspondingly to be considered good for leaseholders. This is not, however, necessarily the case.
There is a clear risk that the reforms will not be implemented as many imagine. Were the reforms to be implemented manifestly in favour of leaseholders, the reforms would significantly reduce the value of freeholds and the Government may hence face legal action by institutional freeholders (particularly with respect to marriage value).
In our view, the reforms may somewhat balance one another out - or even benefit freeholders. For example, although marriage value may be abolished, the Government could decide to fix the rates used in the valuation calculation at a level which is punitive to leaseholders. Reductions to the premium payable for statutory lease extension may hence be significantly less than anticipated.
For example, a property with a freehold value of £300,000, with 75 years remaining on the lease, and with annual ground rent of £100, would (in our view) require a premium of £23,800 for statutory lease extension, of which £13,800 would be marriage value. This assumes a standard ground rent capitalisation rate of 6% and a deferment rate of 5%.
One would think that abolition of marriage value would hence result in a large saving given these figures. However, if we re-run the same calculation with a capitalisation rate and deferment rate of 2.25%, the premium payable rises to £54,600 and marriage value falls to zero.
2.25% represents the “risk free rate” defined as “the return demanded by investors for holding an asset with no risk”. Whilst it is unlikely that the Government would prescribe a risk-free rate for the calculations it is worth noting that the “over 30 not over 30.5 year” National Loans Fund interest rate used for freehold valuations with intermediate leasehold interests has fallen from around 4.5% in July 2010 to 1.3% as of July 2021.
If we apply the lower end of the yield rate range suggested in the Law Commission's report of 3% then a premium of £36,350 is obtained for the above calculation, of which only £1,250 relates to marriage value. The abolition of marriage value in this circumstance would hence relate to an overall net gain of £11,300 for the freeholder as compared to current valuation methodology!
As always, with any proposed leasehold reform it is important to pay attention to detail. If you are a leaseholder with a remaining lease term approaching 80 years you should secure a lease extension, or purchase of your freehold, now rather than waiting for future reforms.
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