How to cut down the cost of enfranchisement

28 January, 2020

Reforming enfranchisement valuations: Law Commission’s report on options to reduce the price payable

One of the key issues raised in the Law Commission’s initial consultation paper to reform the residential enfranchisement regime was, what should it cost to enfranchise?

As part of the Law Commission’s body of work to generally provide a better deal for leaseholders to make enfranchisement easier, quicker and more cost effective, the Law Commission has recently published their latest report.  This sets out options to reduce the premium (price) for leaseholders looking to buy the freehold of houses or extend their leases of flats, whilst ensuring sufficient compensation is paid to the landlords to reflect their property interests.

Current law

The problems with the current law is that it is complex, has unpredictable and potentially arbitrary outcomes.  Leaseholders have advocated for reform to lower the cost.

Under the current law, when a leaseholder exercises the right to enfranchise the total cost to the leaseholder is comprised of professional costs and the premium.  Calculating the premium involves putting a financial value on the interest being obtained by the leaseholder from the landlord.

Broadly speaking the premium is intended to reflect the market value and comprises of three elements:

  • Term:  the value of the landlord’s right to receive the ground rent for the remaining unexpired term of the lease.  This sum is calculated by applying a capitalisation rate to the rent to be lost over the expired term of the lease.
  • Reversion:  the value of the landlord’s right to have the property back when the lease expires.  A deferment rate is applied to find a capital sum which, if invested now, would provide an equivalent value on expiration of the unexpired term of the lease.
  • Marriage value:  an additional value to reflect the fact that owning a freehold outright (where leasehold and freehold interests are merged and “married”) is worth more than the separate ownership of freehold and leasehold interest.  This is calculated by working out the relative value of the leasehold interest in a property compared to the freehold interest in the property and the percentage used is known as relativity.  (Hope value is associated to marriage value and is the deferred form of marriage value if the freehold is sold to a third party (not the leaseholder).  That third party might “hope” that they will sell the freehold to the leaseholder in the future.  This future possibility is the hope value).

3 Schemes

The report proposed 3 schemes for determining the price of enfranchisement.  The main difference between the schemes is whether marriage value is payable (it is not included in scheme 1, it is partly included in scheme 2 and it is included in scheme 3).  Accordingly, leaseholders are likely to benefit from schemes 1 and 2.

  1. Scheme 1 – Term + Reversion:  This scheme reflects what the landlord would achieve if the lease ran its course and the leaseholder never chose to enfranchise; the landlord would receive ground rent and would get the property back at the expiry of the lease.  It is assumed that the leaseholder is not in the market and never will be in the future.  This therefore produces a premium based on the term and the reversion (not marriage and hope value).
  2. Scheme 2 – Term + Reversion + Hope Value:  This scheme reflects what the landlord would receive if the landlord’s interest was sold to a third party.  It is assumed that the leaseholder is not in the market but may be in the future.  This therefore produces a premium based on the term, reversion and in some cases hope value (not marriage value).
  3. Scheme 3 – Term + Reversion + Marriage Value:  This scheme reflects the current law and reflects what the landlord would receive if the landlord’s interest was sold to the leaseholder.  It is assumed that the leaseholder is in the market.  This therefore produces a premium based on the term, reversion and marriage value.

7 Sub-options

Alongside the 3 schemes, further sub-options have been proposed which could feature in any of the 3 overall schemes.

  1. Prescribing the capitalisation rate, deferment rate and relativity (used to calculate the elements of Term, Reversion and Marriage Value) which is the key source in disputes to make the process more predictable.
  2. Capping the level of ground rent at 0.1% of the freehold value of the property.  The ground rent is used to calculate the Term element and some leases contain onerous provisions that the ground rent will increase in the future.
  3. Giving the leaseholder in collective enfranchisement the power to accept a restriction on future development, for instance, building further floors on top of the block, in order to avoid paying an increase in premium to reflect the “development value”.
  4. Reduced pricing for leaseholders who are owner/occupiers rather than commercial investors.
  5. Removing the obligation for leaseholders to pay 50% of the marriage value if the lease has 80 years or less left to run.
  6. Removing or simplifying the discount to the value of the freehold which is as a result of an improvement carried out by the leaseholder.
  7. Removing or simplifying the discount to the value of the freehold which is as a result of the leaseholder’s right to hold over after the lease comes to an end.

Assuming sub-option 1 is adopted, an online calculator could be created to make it easier to find out the cost and reduce the uncertainty around the process.

Although the adoption of a simple formula (based on a ground rent multiplier or on a percentage of freehold value) was initially raised in the Law Commission’s consultation paper, this has not been put forward as an option in this latest report, albeit it may be used in some limited cases.  Freehold investors will welcome this “one size does not fit all” approach as there is high risk that a simple formula would not reflect the true value of the asset to the landlord and as such is likely to be incompatible with Human Rights Law which provides for protection of property and states that no-one shall be deprived of their possessions except in the public interest and subject to the conditions provided for by law and by the general principles of international law.

Future reform

Interests of landlords and investors versus leaseholders are very much opposed and striking a balance between these parties will be difficult, particularly in relation to valuation.  The report does not express a view as to which options should be adopted; this is a decision for Government as it involves considerations of law, valuation, social policy and political judgment.  It will be for the Government and ultimately Parliament to decide which of these options to adopt.

The Law Commission is continuing to finalise its recommendations for all other aspects of the enfranchisement regime and we can expect more reports over the next few months.

It remains to be seen when and what reforms will become law.