The case that rocked the leasehold valuation market

What is the Deferment Rate?

To enfranchise, lessees must pay a sum representing the aggregate of three elements:

• value of the freeholder’s interest in the premises;
• freeholder’s share of “marriage value”; and
• any compensation payable to the freeholder in respect of losses suffered in respect of other properties.

The statutory provisions for the assessment of the price payable on the purchase of the freehold of a home under the Leasehold Reform Act (‘1967 Act’), or the value of the landlord’s interest on collective enfranchisement under the Leasehold Reform, Housing and Urban Development Act 1993 (‘1993 Act) are in essentially similar terms.

In each case, calculations are based on a number of assumptions:

• landlord’s interest is sold on the open market by willing seller;
• the relevant Act does not confer the right to acquire the freehold/extend the lease –“no-Act World” assumption; and
• neither the tenant nor other parties with special interests, are seeking to buy – “exclusion of tenant’s bid” assumption.

The landlord’s interest in premises subject to a lease is to:

• receive during the term the rent reserved; and
• on the “no Act” assumption, the right to vacant possession at the end of the term.

These two terms are valued separately; the first by capitalising rent over unexpired years and the second, by assessing the capital value of the premises on the basis no lease has been granted and then applying a deferment rate to reflect the fact that vacant possession will arise in future i.e. the lease expiry date. The deferment rate is therefore the rate of compound interest that would need to be earned on an investment made at the valuation date to produce at the end of the term the capital value that has been determined as being open market value of the interest.

What is being ascertained therefore is a valuation tool to be applied to the current open market vacant possession value, which can be ascertained by market evidence.

Assessing the Deferment Rate –The Early Years

In 1989 a Tribunal heard evidence of how 334 claims had been settled at the deferment rate of 6%. The Appeal Court later went onto accept this as good evidence of “the land-market” and on this basis, the deferment rate of 6% has been applied as the established figure on London’s Cadogan Estate.

The Decision

The five appeal cases concerned the price payable on enfranchisement claims for houses and flats in Central London. The Lands Tribunal heard various valuers address the question of appropriate deferment rates for leasehold valuations. The lead case was Arbib v Earl Cadogan .

The Tribunal’s ruling caused great stir for two reasons. Firstly, Judge Rich QC ruled merely treating a figure (6% deferment rate) arrived at by historic convention and successive legal decision as one set in stone, to be a failure to address evidence properly. He followed the Appeal Court’s decision in Curtis v London Rent Assessment Committee which highlighted the dangers of treating one tribunal valuation as precedent for subsequent decisions, in place of evidence.

Secondly, the tribunal ruled Gallagher Estates and Walker had been misunderstood; surveyors had interpreted it to mean financial market evidence is inadmissible when determining an accurate leasehold market value. The tribunal ruled this was incorrect and instead held where there is no other suitable evidence financial markets can and must be considered.

The tribunal distinguished between relying upon a conventional figure and adopting a conventional method of valuation. The best approach they concluded was:-

• To consider the money market in the absence of dependable market transactions to provide evidence of value.
• The starting point is a risk free investment; they decided index-linked gilts yielding 2% are the best risk-free investment.
• For the Cadogan Estate, a deferment yield of 4.5% compared to index-linked gilts at 2%, made sufficient allowance for general risks perceived by the market i.e. need for management, the asset being destroyed and/or expensive to realise at the end of the term.
• An additional 0.25% was applied in the lead case as it was thought to be an unusually large amount to invest in a single house (deferment rate was 4.75%).
• Further, due to lesser management problems for houses, a further 0.25% should be added for flats. The tribunal also noted its discretion to make adjustments for physical differences, size, length of term and location.

Conclusion

As the Tribunal itself ruled, there is danger in treating one tribunal valuation as precedent for subsequent decisions in place of evidence.

Buyers, sellers and practitioners alike will have to be wary of falling into the trap of relying upon this decision as evidence of lower deferment rates. Nevertheless, on the basis of this decision, it seems the price to enfranchise is set to increase whilst the value of leasehold property decreases. Are tenants now really going to want to enfranchise until it becomes absolutely necessary?

For further information regarding this article, contact Roger Hardwick, Head of Leasehold Enfranchisement, Brethertons Solicitors.