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.