Collective Enfranchisement

(a) valuing “the reversion”

The value of the landlord’s interest in a flat let on a 40-year lease is higher than a flat let on a 130-year lease. To calculate the difference, valuers apply a “deferment rate” to work out the difference between what the property will be worth on a lease which expires in 40 years’ time and what the property will be worth on a lease which expires in 130 years’ time. The value is *L. & T. Review 91 calculated by taking the current freehold value of the flat and multiplying it by the appropriate deferment rate for the required number of years.

There is no mention of a “deferment rate” in the Act, but this methodology has been accepted in the courts and tribunals as appropriate. For properties in prime central London, the Upper Tribunal has effectively fixed the deferment rate for flats at 5 per cent (see Earl Cadogan v Sportelli [2007] 1 E.G.L.R. 153. However, with decreasing interest rates, it is possible that, if there was a re-run of the Sportelli case, the market deferment rate might well be found to be lower than 5 per cent. The rate applied to calculate the appropriate damages for a fund paid under the Fatal Accidents Act 1976 is considerably lower. The lower the deferment rate the higher the premium.

(b) valuing “the term”

The next question is how is the loss of the rental stream calculated? It is not as simple as multiplying £100 x 40 years because under the terms of the lease, the landlord is only entitled to £100 each year so it will have to wait 40 years to get all the rent. The rent, therefore, has to be capitalised to reflect the benefit of receiving a lump sum now for the whole rent. This lump sum is calculated using a “capitalisation rate” which is converted into a multiplier called a “Years Purchase” multiplier based on the capitalisation rate and the number of years left on the lease. If there are fixed rent review increases, the capitalisation rate can be applied to each of the increases. The position becomes rather more complicated if the rent reviews are not fixed but subject to, say, RPI increases.

Capitalisation rates have, in the past, usually been agreed—for modest ground rents the capitalisation rate is usually between 5 and 8 per cent. However, recent cases suggest that these capitalisation rates are out of step with the current market. In St Emmanuel House (Freehold) Ltd v Berkeley Seventy-Six Ltd FTT CHI/21UC/OCE/2017/0025 (known as the All Saints Case), the tribunal was persuaded that the appropriate capitalisation rate was as low as 3.35 per cent! Again, the lower the capitalisation rate the higher the premium. The prevalence of “onerous ground rents” has meant that the value of the capitalised rent is now worth fighting about. If the rent doubles every 10 years, it is potentially a very valuable asset and the capitalised ground rent can form a significant part of the premium payable to the landlord.

(c) valuing “marriage value”

The most contested part of the premium, however, is invariably the “marriage value”. This requires a comparison between the value of the flat on the existing short lease and the value of the flat on the basis that it is freehold. All this has to be done on the assumption that the leaseholder does not have the right to extend his lease or purchase his freehold under the 1993 Act. This is highly artificial because, of course, the Act does exist and purchasers in the market know that they have the right to enfranchise.

Ideally, the value of the short lease will be determined from market evidence but truly comparable sales of flats with the same lease length can be rare. Even if a comparable sale can be found, it has to be adjusted to reflect the “no Act” world. This is done by applying a percentage discount and further disputes can arise as to what that discount should be. Valuers, therefore, resort to relativity graphs. These express the value of the short lease as a percentage of the value on a freehold basis. So, for example, if the existing 40-year lease is worth £65,000 in the “no Act world” and the freehold would be worth £100,000, “relativity” is 65 per cent. The lower the relativity the higher the premium, the tenant will pay for a new lease. *L. & T. Review 92

Experts have been unable to agree on a definitive graph, so there are a number of different graphs in circulation and disputes arise as to which graph is appropriate. All of the graphs have been criticised. Again, recent cases such as Sloane Stanley Estate v Mundy [2016] UKUT 226 (LC) and thereafter, suggest that many of the graphs may currently overestimate relativity. Again, the lower the relativity the higher the premium.

How is the price of the freehold on a collective enfranchisement calculated?

In the case of a collective enfranchisement, the purchase price is essentially the sum of:

  • the value of the term and reversion of the flats and other units in the building;

  • marriage value in respect of the flats of leaseholders who are participating in the enfranchisement claim;

  • hope value” in respect of the flats of leaseholders who are not participating in the claim; and

  • development value.

Hope value” is the sum which a hypothetical purchaser of the freehold might be willing to pay to reflect the “hope” that one or more of the non-participating leaseholders may wish to purchase a lease extension in the future. It is calculated as a percentage of the marriage value. The more likely it is that the non-participating tenants will want a new lease, the higher the percentage of the marriage value is payable. “Development value” is the value which the landlord might have been able to achieve by developing those parts of the estate which it can develop. Again, the potential development value is discounted to reflect the chances of the landlord actually being able to release this value. There are a number of obvious problems with the current methodology:

  • it is complicated and needs an expert to interpret it. It is, therefore, expensive to operate;

  • it is subjective, different experts will think different rates are appropriate to calculate the true value;

  • it is artificial in that it requires a calculation to be based on “comparables” which do not exist (i.e. market sales which took place in a world which does not allow for enfranchisement). Similarly, it requires payment of development value where the landlord/hypothetical purchaser has not carried out a development and may have no intention of doing so;

  • leaseholders would say, it gives rise to high premiums, particularly if they are caught up in the ground rent scandal of doubling rents.