By Dean Buckner
The government has come up with a figure of £27.3bn to estimate the value of the entire market for residential freeholds were existing ground rents to be set to a peppercorn.
This is the first option in the ground rent consultation, and the one obviously the most beneficial to leaseholders, which is why LKP is urging leaseholders to take part and opt for it.
The government’s impact assessment of the changes to ground rent were published two days ago:
In the case of a peppercorn ground rent, the government’s £27.3bn figure comprises £5.1bn based on the present value of the ground rent over the first 10 years of lease terms,. The remaining £22.2bn is based on the change in asset value caused by the loss of ground rent income over the remainder of lease terms.
There are two key points here.
First, although the government methodology has not been spelled out, it seems it has used a discount rate (3.5%) that is somewhat lower than the current long term (30 year) discount rate of 4.75% (as of 8 December 2023).
Thus the figure of £27.3 may well over-estimate the impact.
Second, and more significant, the freehold market has known for a very long time that there was political risk attached to the assumption that ground rent income would benefit freeholders in perpetuity.
In Scotland, the feudal system was abolished by legislation passed in 2000 (Abolition of Feudal Tenure etc (Scotland) Act 2000), including the abolition of feuduty, a fixed annual payment granting the right to the use of land, similar to the ground rent payable in England and Wales.
A risk that was realised in Scotland could equally well be realised in England and Wales. Furthermore, the prospect of ground rent reform has been mooted since at least 2017.
Markets recognise the existence of risk and price it in by means of a “spread”, an amount added to the discount rate.
In estimating the impact on asset value the government should recognise the fall in market value, not some other theoretical value.
For example, a market value of only £10bn for ground rent assets would mean that freeholders could offload their assets at £10bn, not some theoretical value of £27.3bn.
In summary, the ‘true’ loss to freeholders should be based on the loss on the realisable market value of their assets, which in turn depends on the higher discount rate applying in the market at the time of writing.
This loss is likely to be significantly lower than the government’s estimate.
Dr Dean Buckner is a former Bank of England economist and a trustee of LKP
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Something Is only worth what the buyer offers and the seller accepts. If the market is flooded with discounted freeholds the price of purchase will inevitably fall as a consequence of sudden and prolonged over supply.
Makes absolute sense, the discount rate for capital projects is much ch higher than the Government has used. However, a key lever for valuation is risk. With Scotland banking over 20 years ago clearly there would be a high discount for real so of legislative change in the future. Both of these items MUST be taken into consideration.
This is so obvious it does make you wonder about the capacity for the Government and Parliament to make a well informed decision.
I have responded to the Consultation paper with arguments for a peppercorn rate.
There is no “free market” value for freeholds and there has not been for years. The is “a market value for freeholds dependent on the law of the land and future expectations of law changes”. The law helped set values 30 years ago, and the use of the law and the way Tribunals interpretted the law allowed landlords to inflate that value massively over at least 25 years, before the fer of change started reversing that process. To be clear – the system has been completely rigged in a way that mean the value of freeholds could only rise, and that cannot be right.
In my view the fairest outcome would involve floating deferment rate (which would currently be set higher than 5% for flats) and a marriage value payment at a level, probably, around 50% of the current level. Any “rip-off” element of ground rents not to be collectable or valued.
You are seeing this only in terms of the enfranchisement calculations accepted by the tribunal. But there is a market in freeholds: they are sold routinely, and anyone could pick some up at auctions. The prices paid to not equal the enfranchisement calculations. Housebuilders ignored all this in explaining to the Communities Select Committee the value of the freeholds, that they create and sell:
https://www.leaseholdknowledge.com/communities-select-committee-lifts-the-lid-on-the-residential-freehold-racket/
My flat freehold belongs to the Ground Rents Income Fund plc (GRIO) traded on the LSE. It is currently trading at a whopping 68% discount to its Net Asset Value (NAV). The *market* is only prepared to pay 32% of what the GRIO director’s claim is the fair value.
I can see that insiders are also buying at this price hopeful of a nice windfall.
So what is the NAV based on. It assumes a range of discount rates from 4.9 – 5.7% based on whether your ground rent is flat, doubling, fixed increases or indexed – nice for some. These are *low* discount rates, an enfranchisement *special* deal for easy-pickings leaseholders, meaning valuation is high. Consider the listed secondary market funds like HICL, JLEN, INPP., BBGI etc. Their NAV is based on 8-9% discount rates; and many of their investments are UK (quasi-)govt payments with change-in-law protection. And even they are currently trading at 15-20% discounts to NAV.
Leasehold needs a sunset date to avoid a 2-tier system and continued horror show. The market has already done most of the work. At current valuations all leasehold can be run-off under 10 years; job done.
The sunset clause was used when dealing with rent charges back in 1977 , and a period of 60 years was given. The capitalization rate used was surprisingly low for very small rent . The compensation terms ensured there was no challenge
The Building Safety Act did impinge on the Ground Rent Income Fund as explains some of the discount, but equally shows that the market does not believe that rents will be capped at nil with no compensation. Equally, Mc Hugh last week auctions showed ground rents being sold at yields of around 5.5%
Investors may take the advice of Nathan Rothschild – “the time to buy is when there’s blood in the streets, even if the blood is your own”
Slight quibble, the market does not currently believe that there is a 100% probability that rents will be capped at nil with no compensation. The ever increasing discount to NAV could be interpreted as the markets estimate of the ‘chance’ that rents will be capped at nil. Around 70%… writing is on the wall
The cost of extending a lease as a percentage of its value did increase from 1993, but this explained by the collapse in interest rates. In 1993 the base rate was around 6% having come down from rates of 10-11% a year or so earlier.
From 2008 to 2021 interest rates were very low indeed and this pushed up house prices, made mortgages cheaper, increased the value of defined pension plans which all benefited the consumer. However, the cost of a lease extension did increase, but it does seem myopic to focus on that and demand that rents be capped to help lower the price of a lease extension – yet ignore the benefits that arose from such interest rate reductions elsewhere in the personal finances
I agree the rip-off element of ground rents should be capped, and they apply to what I describe as “pernicious” rents as opposed to “onerous” rents
For pernicious rents, the initial ground rent should stand, and future rises linked to the RPI unless the planned rises produce a lower figure.
For onerous rents, the leaseholder who feels aggrieved that the initial rent was too high must seek redress from whoever advised them, they cannot expect the taxpayer or the developer to make good the overpayment made in the deal.
What is the cost to this country reputation of tearing up contracts where both parties were represented professionally and there being a period of 2 months or so for quiet reflection of the proposed lease terms before signing up to them.
Many outsiders would see this proposal to cap ground rent at a peppercorn with no compensation as confiscation of legitimate legal rights and wonder what other attacks on our contract law may be coming our way.
The unpicking of a contract many years after it was signed on the basis that the freeholder/developer received sufficient consideration when the premium was paid and that the ground rent is an unjustified stream of further consideration, alarming. Notwithstanding, it was set out very clearly in the contract and had been the custom for some three hundred years
This would open the floodgates to have all sorts of contracts re-visted , many contracts were entered into by the purchaser/consumer strightaway without being legally represented.
Oh Stephen, you live in these comment sections and I love it! Hope you enjoyed the debate yesterday! And then, keyboard at the ready, to the LKP website you go to share your views. The knight in shining armour the RFA was waiting for.
I assume you also objected to the abolition of slavery on the same grounds? All of your points on contract law and property rights would apply just as well to that. But civilisation evolves, and we get better.
In a leasehold contract both parties reached an agreement they were happy with at the time, otherwise the deal would not have gone ahead.
In slavery that was clearly not the case
My point was that the buyer and seller of the slaves were also happy with the deal at the time. But the product (slaves or property’s blighted by ground rents) were subsequently deemed as something that is not desirable and so should be abolished. (Freeing the slaves, capping the ground rents). And yes, at the time, there were those that disagreed with the premise that the product was immoral, much as I’m sure you disagree that ground rents are wrong.
On a less confrontational point, your counter proposal to deal with only pernicious rents by capping them at RPI. How would this work in the enfranchisement calculation? Would you support the assumed rate being prescribed at the 2% target, or leave it something to be negotiated?
Why are England & Wales the only two Country’s on Earth that currently have Freehold & Leasehold?
Any Government can enact a Law amend a Law or abolish a Law, it is called Democracy. Governments are elected by the people to represent the people and to carry out the will of the majority. This system of representation has stood the test of time for Century’s, its not perfect but I for one can think of nothing better than British democracy.
I believe that the Freehold racket got completely out of control and had it effectively self regulated when it had the opportunity to do so. they would not find them selves in the firing line of abolition. they have no one else to blame for that Industry’s abdication of all control and proven exploitation of Leaseholders.
Agree it’s not required and not valid.