Leasehold reform and enfranchisement: is the price right?

The Law Commission has published a report on the options to reduce the price payable by leaseholders wishing to extend their lease or acquire the freehold of their property whilst ensuring sufficient compensation is paid to landlords to reflect their legitimate property interests.

Complexity, unpredictable outcomes, delays and inequality are just some of the problems with the current law highlighted by the Law Commission.

Human rights considerations have also formed a key part of the Law Commission project. Any change in the law must ensure a landlord’s human right (which covers both individuals and legal entities) to peaceful enjoyment of their property is not breached. Any revised enfranchisement rights will only be lawful if the level of compensation payable to the landlord is sufficient to justify the interference with their property rights. The Law Commission has only put forward options that are likely to be compatible with a landlord’s human rights.

The options and the terminology

The full report is over 300 pages long but we set out below a short summary of the three main options for reform put forward by the Law Commission.

In considering these options it is worth noting that the ‘mainstream valuation basis’ currently applies to the majority of claims for enfranchisement. Where the mainstream valuation basis is used there are three key elements to the premium calculation and the terminology is relevant to the options put forward:

The ‘term’: replacing the ground rent income with a capital sum.

The ‘reversion’: the value of the right to have the property back when the lease expires.

Marriage value: Where the lease has 80 years or less to run, the legislation requires the leaseholder to pay half of the marriage value to the landlord. Marriage value is not payable where the lease has more than 80 years to run. Marriage value is an additional payment to reflect the fact that the value of owning the freehold outright is worth more than the sum of the freehold and leasehold interests in separate ownership. Marriage value is also payable where a lease is being extended under the statutory regime.

In its report and as part of its recommendations the Law Commission also considers ‘hope value’. The Law Commission notes that hope value is a deferred form of marriage value. If the freehold is sold to someone other than the leaseholder, marriage value will not be realised as a result of that sale. However, the purchaser might “hope” that they will sell the freehold to the leaseholder in the future, which will realise marriage value. The purchaser may therefore pay an additional amount now to reflect that future possibility. That additional amount is “hope value”. An individual leaseholder never pays both marriage value and hope value.

The Law Commission has put forward three schemes for calculating premiums moving forward. In short the elements used to calculate the premiums would be as follows:

Scheme 1: Term + Reversion

Scheme 2: Term + Reversion + Hope Value

Scheme 3: Term + Reversion + Marriage Value

The Law Commission notes that schemes 1 and 2 would reduce enfranchisement premiums and that scheme 3 reflects the current law.

Within these overall schemes there are sub-options for reform which could impact on the premium payable:

• One option favoured by the Law Commission is prescribing the rates which are used to calculate each element of the premium. These rates are often disputed and can lead to litigation between the parties. Premiums would be reduced for leaseholders if the rates were prescribed at below market levels.

• When it comes to calculating the element of the premium attributable to the term a cap on onerous ground rents is suggested. The ground rent would be capped at 0.1% of the freehold value of the property (this saw a reduction of over £70,000 in the premium payable in an example given by the Law Commission).

• Where a group of leaseholders is looking to acquire the freehold of their block and there is development potential, the Law Commission has put forward an option whereby the leaseholders could accept a restriction on the title preventing future development and therefore avoiding an upfront payment for development value. If in future the leaseholders then wished to develop they would have to negotiate with the former landlord to release the restriction.

• Different pricing for different types of leaseholder; owner occupiers would benefit from reduced premiums but commercial investors would not. This is hard to define and the ownership arrangements can change over the life of the lease (what is today a purely commercial investment, with a block management arrangement etc. with all the hallmarks as being a “commercial investment” might become a traditional owner-occupied property in the future – and vice versa). Linking the arrangements to occupation seems undesirable and the Law Commission note this in their report.

• Depending on which scheme and reforms are implemented the 80 year cut off in respect of paying marriage value would either be removed (as it would become irrelevant) or retained (otherwise leaseholders with more than 80 years left to run on their leases would see premiums increase).

• Simplification of the discount for leaseholder improvement and the discount for the risk of holding over are also recommended (and the possibility that these could be removed altogether if other reforms were implemented).

The Law Commission highlights the advantage of introducing an online calculator for leaseholders noting this would be simple to use and provide certainty in relation to the premium. However, this could only be introduced if rates were prescribed.

Legislation will need to be enacted to implement any reforms and the Law Commission is clear that it is for the Government and parliament to decide how premiums should be calculated.

Comment

For those with interests (debt or equity investments) in residential ground rents, one potentially crucial evidential factor in how the 0.1% cap on ground rents might apply is establishing whether the “onerous” ground rent was factored into the premium/price paid by the tenant on acquisition of their interest. We imagine that in most cases, for owner occupied residential units evidence of that is going to be thin or non-existent. However, for structured ground rent investments (eg where the tenant has acquired a leasehold interest purely as an investment and also enters into management arrangements for a professional manager to let the property on their behalf) then there may be some evidence available. We doubt the new legislation will seek to distinguish between an “ordinary” owner occupied ground rent lease arrangement from that pure, structured investment type arrangement – both of which comprise a long lease of a flat to be used as a dwelling. The Law Commission have clearly signed posted their dislike for making such distinctions.

The Law Commission will publish three further reports shortly. These will look at:

• all other aspects of a reformed enfranchisement regime;
• right to manage; and
• commonhold.