The Real Cost of Sportelli for Landlords and Leaseholders

Bone of contention

The origin of the dispute can be traced back to the Leasehold Reform Acts that provide a number of mechanisms so that leaseholders are able to extend their lease or join together with their neighbours and purchase the freehold on the building. However, the amount the leaseholders should pay the freeholder is often a bone of contention as the purchase price in such cases depends on a number of complicated factors and formulas.

The Sportelli case centres on what is known as the deferment rate. This applies when a tenant is paying for an asset, such as a lease, that the freeholder will get back at some point, known as leasehold reversions, in the future (usually between 30-80 years). In order to compensate for this the price is usually set at the amount that would be the same as the value of the property when the lease eventually expires and the interest rate is known as the deferment rate – therefore the higher it is, the less that the tenant has to pay up front.

Up until 2003, such cases presumed a deferment rate of six per cent within the centre of London. However, freeholders soon began to question this assumption arguing that the deferment rate should be concordant with the yields on other sorts of investments. In September 2005 the question was addressed by the Lands Tribunal in Arbib vs Earl Cadogan when it ruled against the six per cent deferment rate and stated that 4.5 per cent should be the normal rate for houses and 4.75 per cent for flats.

In what has become viewed as a landmark decision, in September, 2006 the Lands Tribunal ruled in Earl Cadogan and Cadogan Estates Ltd and others vs Sportelli and others, that a deferment rate of five per cent should apply to flats irrespective of location, obsolescence and condition.

Paragraph 88 of the judgement states: “While we accept the view of the valuers that the deferment rate could require adjustment for location, on the evidence before us we see no justification for making any adjustment to reflect regional or local considerations either generally or in relation to the particular cases before us.” The decision obviously means that a well-kept, luxury penthouse in the heart of London would be subject to the same deferment rate as a small run down flat somewhere in the suburbs, which has caused a lot of controversy and differing opinions. One viewpoint is that the ruling unfairly favours London’s big landowners and although the decision may be good for the leaseholder in the short term, it is the freeholders who will eventually benefit from the ruling.

David Goldstone MRICS of enfranchisement experts John D Wood & Co in London said: “The Sportelli decision is fundamentally flawed because it applies the same five per cent rate whether dealing with a flat in a prime block in Chelsea or a small flat in a deteriorating block on a main road in a suburban area. This has effectively swung the pendulum back in a small way in favour of all leaseholders, by reducing the cost of buying a lease extension or the freehold of a property.

“However leaseholders did benefit prior to the Arbib decision of September 2005 from higher deferment rates in excess of six per cent and therefore a much lower cost. Taking the full effect of both the Sportelli and Arbib decisions into account, the freeholders have scored a major victory in increasing the cost of buying a lease extension or the freehold.”

Industry experts

What makes the Sportelli case so important and intriguing is the variation of opinion that it musters among industry experts. Roderick D Baker, a Fellow at the Royal Institute of Chartered Surveyors disagrees with the view that the Sportelli ruling favours the freeholder in the long run.

“All ground rents are very secure against the asset on which they are paid. It therefore matters not whether the property is in a prime block in London or in the suburbs. The flaw in the past has been that the percentage used for capitalisation and deferment rates have been slavishly followed from one decision to another, without taking into account what the market is doing.

“Analysing ground rent sales does not, in my experience, show wildly different rates from area to area. The overwhelming influence on these investments is the money market rates. Market evidence must be brought into these valuations as far as possible. It would be equally wrong for the rate to lock at five per cent if the capitalisation rate rises.

“Let us not lose sight of the fact that enfranchisement legislation enables leaseholders to acquire their freehold or extend their lease, but not to steal it.”

On February 7th 2007 the Court of Appeal granted leave to appeal the Land Tribunal determination and the case was considered on July 23rd 2007.

A decision is expected soon. For updates please see www.newsontheblock.com