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