Linz Darlington, of Homehold, which offers lease extension services to leaseholders, explains how successful freeholder lobbying over deferment rates could undermine all the gains given to leaseholders with the ending of marriage value
There has been a huge amount of positivity around the recently introduced Leasehold and Freehold Reform Bill, and so there should be. It has been billed by the government as making it cheaper and easier for leaseholders to extend their leases.
And it has the potential to do this, particularly making it more affordable for those leaseholders with leases with fewer than 80 years remaining, or those paying a high ground rent. A major win is the abolition of “Marriage Value”, which removes the requirement for the leaseholder to share the hypothetical profit that they’ll make when they extend their lease.
The Bill is a credit to years of campaigning by LKP, with support from the National Leasehold Campaign.
The press has reported the missing headline promise to ban leasehold houses, but this easily remedied faux pas is a distraction from a far more concerning and potentially sinister omission from the Bill: the key rates used for calculating lease extension and freehold purchase premiums.
What are these key rates?
Imagine you have 80 years left on the lease of a £200,000 flat with no ground rent. The cost of a lease extension would be about £4,000. This £4,000 would essentially be paid to the freeholder for the loss of their flat back at the end of the 80-year term.
The reason it is £4,000 is as follows: if you put that amount in the bank at 5% and left it there for 80 years it would grow to about £200,000. That’s why it is considered £4,000 today is comparable compensation to the loss of £200,000 in 80 years’ time.
The 5% “Deferment Rate” has been used in nearly all lease extensions of flats since a Court of Appeal case in 2007 known as Sportelli.
If the lease dropped to below 80 years – even by just a day – the premium would increase to about £12,000. The additional £8,000 is the landlord’s share of Marriage Value. Marriage Value is payable under the current legislation but should be abolished by the new legislation.
So, what’s the problem?
The issue is that this Deferment Rate and the rate for discounting future ground rent schemes has not been specified in the legislation.
This an enormous problem. Whether or not the Bill fulfills the policy objective of making it cheaper for leaseholders to extend their lease, or actually makes it more expensive, turns entirely on a few digits which have yet to be set.
To put in context: if Marriage Value was abolished in the example above then the premium would drop from about £12,000 back to £4,000. This is clearly very good news for the leaseholder.
However, if the Deferment Rate was reduced from 5% to 4%, the premium would increase to about £8,500 – i.e. closing about half the gap. If it was reduced to 3.5% then the premium would be back at £12,000 again.
Any decrease in Deferment Rate for leaseholders with leases below 80 years will essentially reduce the benefit of the abolition of Marriage Value. However, it is unlikely to result in an increased premium beyond what they would pay under existing legislation.
However, leaseholders extending leases that have more than 80 years are not required to pay Marriage Value. This means that any reduction in the Deferment Rate would increase the premium they pay.
So, who will set the rate?
All the legislation does is say that the rates will be set later by the Secretary of State through secondary legislation, and then reviewed periodically every ten years.
Frustratingly, this means that this critical part of the Bill will not actually receive the same legislative scrutiny as the Bill itself. Instead, it will be set behind closed doors by the Secretary of State – possibly after the Bill has been passed.
To claw back some of their loss of Marriage Value, it is highly likely that the freehold community will launch a lobbying offensive on the government to set the rate at a lower level than the current 5% rate, which is essentially prescribed by Sportelli.
Compounding the problem, during the consultation process the Law Commission was sufficiently concerned about freeholders arguing that their human rights were being infringed by the changes to enfranchisement law, that they sought the opinion of Catherine Callaghan KC. She concluded that to avoid a successful challenge, the rates prescribed would broadly need to be at market levels.
Catherine Callaghan KC concedes in her opinion that valuation is not an exact science and there is opportunity for argument between valuers about the correct market level. In the most recent Upper Tribunal Case on Deferment Rates the freeholder contended for a rate of 3.5% and we can assume their valuers will be sharpening their tools to continue this argument.
What do we do about it?
During the Committee Stage there will be an opportunity to submit evidence to Public Bill Committee on what should be changed in the Bill.
We need to be encouraging them to add into the primary legislation that the Deferment Rate should never be set at a rate lower than 5%, if they want their policy objective to be achieved.
Related posts:
If you want to reform enfranchisement push government hard, is message of Law Commission
Analysis of where next with the Leasehold Reform (Ground Rent) Bill
Marriage value a bogus profit in the £2.5bn enfranchisement racket, LKP trustee Dean Buckner tells BBC
APPG recognises efforts of Law Commission to improve enfranchisement
Work with this leasehold reform Bill, or wait for Utopia? Minimum: another 3 more years
Marriage value? Let’s have an acrimonious divorce!
The 1993 Act gave flat owners the right to extend their leases. Clearly this infringed the human rights of the landlord as they had up to then the certainty of receiving back the property at the end of the term. To compensate them so to fend off a challenge at the European Court of Human Rights a formula was agreed which sets out the formula and for the last 30 years that formula has been tested and there is a large amount of data to determine with some accuracy the premium that needs to be paid.
Back in 1993 interest rates were much higher and with the collapse in interest rates this has caused house prices to rise and the premium to extend the leases has increased enormously.
At the time of the seminal case on deferment Sportelli 2006 when the rate of 5% was set the risk-free rate was 2.25%. At that time the risk-free rate used in injury cases was 2.5% and therefore in line with Sportelli view
However there has been a collapse in long term rates and the Ogden rate in 2019 was set at MINUS 0.25% a collapse of some 2.75%
Therefore, if the case Sportelli was heard today the deferment rate may well be in the range of 3.5% to 4%. At these figures marriage value disappears.
The government have indicated that the rate once set will be fixed for 10 years and some commentators believe that this may be preparing a deal with inevitable challenge on human rights that a rate will be set at say 4% and guaranteed for the next 10 years at least.
I disagree with you, and I think it is wrong to have as the floor a deferment rate of 5%, it does not reflect that reality that the risk-free rate has shifted since 2006. This will of course as you say will be the subject of an enormous challenge by the Great Estates who hold large amounts of reversionary ground rents.
If this comes about the cost of a lease extension where the term is above 80 years will bizarrely be greater.
Marriage value arises because the deferment rate and capitalisation rates are too high. In a perfect market and no act world, marriage value would not exist. It is because the market does no operate efficiently that we have marriage value and that is why relativity has been increasing over the last 17 years because the risk-free rate collapsed and the 5% deferment rate set in Sportelli was not lowered.
A leaseholder with lease in the low 80’s should I think act now. The idea that the ground rent will be lowered to zero with the freeholder receiving no compensation is very unlikely. This amounts not only to tearing up contracts but also seeking to amend a previously agreed formula, not because of changes in interest rates but seeking to advance an argument that ground rent is not some form of deferred consideration agreed at the time of the sale.
I had to double check the date of your comment. Unless you have been under a rock for the last 2 years, you will have noticed long term rates are now significantly HIGHER than the 2.25% you mentioned at the time of Sportelli. (30Y gilts are 4.5%).
Not sure why you pulled something from 2019, unless you just chose to go a far back as you needed to find something that fits your agenda?
Ultimately rates will move around all the time, and I think it’s reasonable for the government to take a long term view and pick something slightly higher than the 5% used today to hit the policy objective of making it cheaper for leaseholders to extend.
On your point about “tearing up contracts”, gov makes changes all the time. I bought UK shares on the basis that corporation tax would be 19%. The governments increase to the tax rate reduced the value of my investment, and no compensation was paid or sought. It’s totally legitimate for the gov to make changes. If you don’t like it, I suggest you vote for a political party that has policy you like in this area… if you can find one 😉
Good comment. Despite making the loss, you acknowledged that the gov is sovereign and they do whatever they want.
The Department for Levelling Up, Housing and Communities seems to have the view that ground rent is for no defined service. I`m sure govt will come to some conclusion that will reduce the costs while staving off the `Great Estates` legal battle. Be very sure whatever the outcome, billions WILL be wiped from their assets. Sounds if govt. aren`t too bothered by that either. They realise a lot of those assets arent earned, they are from rinsing their tenants over a few hundred years and more recently by the back of a fag packet calculations…
The question is will they have the fight for it when the legal bills arent footed by their leaseholders? Nah.
Ground rent is for no defined service. Unless you can tell me what that service is?
You are correct it is for no defined service. The lease makes that clear . Services charges are used to maintain the property the ground rent goes to the freeholder with no obligation being placed on the freeholder to do apply it to the property
It is deferred consideration . If a flat is sold for £250k with a ground rent of £350 linked say to the RPI the total consideration is £250k plus about £10k being the capitalised value of the rent – so the freeholder gets £260k
That deal is set out clearly in the draft lease and the leaseholder with their solicitor can comment , seek to renegotiate before deciding whether to go ahead , If you sign up for it then you really must do what you contracted to do and pay this ground rent.
what this consultation process is implying is that the leaseholder has agreed to pay too much and part of the consideration agreed ie the ground rent should be cancelled. Our contract law does not allow contracts to retrospectively pulled apart if the purchaser believes they may have overpaid by 3% to 5% some years earlier – even more so when the purchaser had professional input for several weeks before signing up
Develops when doing their project evaluation to decide how much to pay for development land factor in the value of the ground rent income that will be created. If they thought the rent was going to be cancelled they would not have paid as much for the land
“they sought the opinion of Catherine Callaghan KC. She concluded that to avoid a successful challenge, the rates prescribed would broadly need to be at market levels”
I’d be curious to see the reasoning behind this opinion. James v United Kingdom [1986] is quite clear on the subject. Quoting directly from the judgment, paragraph 54:
“Legitimate objectives of “public interest”, such as pursued in measures of economic reform or measures designed to achieve greater social justice, may call for less than reimbursement of the full market value.”
The 1967 Act gave compensation below the market value that the freeholds interest would have sold for – but there was compensation. This proposal is for none at all, and the sums involved for 95% of lessee is less than a £1 a day. Yet the consequence for the United Kingdom could be very serious, it would be in effect the confiscation of property rights without compensation, something akin to the wild days in Zimbabwe. This would affect this country’s ability to do business worldwide and have consequences in the commercial property market.
A ground rent which is above 0.1% seems to be regarded as onerous, and that is a red flag to the prospective purchaser that the financial burden needs to be reflected in the purchase price. So a ground rent of £10,000 per annum is clearly onerous, BUT if the purchase price is reduced by say £200,000 that rent ceases to be regarded as onerous and the bargain whereby the purchaser acquired the leasehold property is fair, and no interference can be justified.
However, a pernicious rent is a rent that does not appear to be onerous, and therefore no red flag is waved, and slips under the radar, but after the contract has been entered into it becomes apparent that the cost of reducing the rent is very substantial indeed . These are the rents that need to be modified by this proposed legislation. I would suggest that any doubling is removed on each review date and replaced with whatever the inflation movement is between the 2 review dates. If this applied to all leases, then all ground rents would remain either the same in real terms from the date they were granted to the end of the term or gradually reduce in real terms if the doubling clause is less than inflation.
The default position must be that if a lease has an onerous ground rent, then the premium must reflect that rent, because the overall package was agreed and completed on. The initial rent is made clear in the lease, as is the review pattern. The leaseholder has a solicitor act for them. If the leaseholder feels that the burden imposed on the property by the ground rent was not reflected in the premium, then redress should be sought from those who advised the leaseholder. Seeking a refund from the vendor because there is a realization later on that the price paid may have been too much is not recognized in our contract law.
However, where the rent is a pernicious rent trapping the leaseholder then legislation should of course come to the rescue and this proposed bill could do that. The near hysteria over ground rents was started by these 10 year doubling ground rents some 7 years ago
So what is the “defined service” Mr Tchenquiz? All I see is the administration costs incurred in invoicing and collecting the ground rent, after the gymnastics of working out how much we should be charged. Where does the money go? Even peppercorn would be a nuisance for the leaseholder. Why any rental charge? It should go the way of the ancient Window Tax, which is when ” Daylight Robbery” was coined.
Mr. Richardson,
I completely agree with your posting it is an Archaic Feudal Law that must be abolished with immediate effect and without compensation to the Freeholder.
Why should the Tax Payer compensate the Freeholder for providing absolutely no goods or services to the Leaseholder?
I am confused… how does a REDUCTION in the interest rate charged, e.g. 4% to 3.5%, result in an increase in the charges?
Yes
If you were to deposit £4,000 in the bank at 5% it would reach c. £200k in 80 years.
If the rate was set at 4% you’d need to deposit a greater amount to reach that £200k.
As a result, the lower the rate the higher the compensation payable.