Key points
• Hedonic regression may be used in the valuation of new leases
• But the Parthenia model should not be put forward in evidence
• The Upper Tribunal has assessed the usefulness of relativity graphs
Following a nine-day hearing, with evidence from four valuers and many other financial experts, the Upper Tribunal (Lands Chamber) (“the UT”) has finally given its decisions on applications to determine the premiums payable in three claims for new leases: Trustees of Sloane Stanley Estate v Mundy and two similar cases [2016] UKUT 223 (LC); [2016] PLSCS 138. These decisions, which occupy 80 pages (including three appendices) may have a significant influence over the valuation of the premiums payable for new leases or enfranchisement. It rejects a radical new way of measuring “relativity”, offers a detailed assessment of the “graphs of relativity” and provides guidance on how to value existing leases on the statutory assumption that there are no rights.
Each application was for a determination of the premium for a new lease (under section 48 of the Leasehold Reform, Housing and Urban Development Act 1993). Two of the leaseholders made their claim against their landlord, the Sloane Estate; the third’s claim was against her landlord, the Wellcome Trust. Given the controversy of the proposed new way of measuring relativity, the First-tier Tribunal, which would normally hear such applications, transferred them to the UT.
What is relativity?
Relativity is an important factor in valuation disputes concerning residential leasehold flats and houses. It may be defined as the relationship between the current value of the flat lease and its “freehold vacant possession” value. Relativity is needed to calculate “marriage value”, that is the additional value generated where a leaseholder obtains a new lease. This additional value is the difference between the current value of the present leaseholder and freeholder interests and their proposed interests after the new lease has been granted. As a rule, the higher the relativity, the lower the premium.
So far, so good. The difficulty, though, is that it requires an assessment of the market value of the existing lease on the assumption that there is no statutory right to a new lease. Such valuations would normally be based on any available market evidence of sales of similar properties, but there is little or no evidence of sales of existing leases that have no statutory rights.
How do valuers (and the tribunals) deal with this difficulty? One answer is provided by publication of so-called “graphs of relativity” by firms of valuers and other organisations. These are compiled by analysing market transactions, settlements and tribunal decisions. But few are entirely happy with this approach and disputes have led to many tribunal cases.
The Parthenia model
This is why the publication of research into the London residential property market during the period 1987 to 1991 aroused such interest. During that period, flat leases did not have statutory rights. Could one extract, from the data gathered, empirical evidence of how the current lease length affects the relationship between the price paid for that lease and the freehold vacant possession value? The research was carried out by a Dr Bracke, an economist. He used a well-established statistical technique called “hedonic regression”. As an analytical tool in economics this is not new and it is by no means confined to residential leases. For years, it has been widely used in many areas of property transactions including the valuation of properties for mortgage purposes. In all, he studied data from some 7,500 sales of properties which had, at the time, no statutory rights. By doing this he claimed that he had unravelled the different components of the transactions that affect the sale price, including unexpired lease lengths. This research became known as the “Parthenia model”. It was considered by the UT in Kosta v Carnwath and ors [2014] UKHT 319 but it was not relied on; the leaseholder had not produced any valuation evidence to support it.
Applying the model to the valuation of one of the three flats in this case revealed a problem: using the Parthenia model, the leaseholder’s valuer arrived at a value of the existing lease higher than its market value with statutory rights (and based on a sale price achieved shortly after the valuation date, that is the date of the claim). As the experts agreed that a lease with rights has a higher value than one without, the contention that this lease had a higher value without rights produces an “impossible” result (paragraph 122). In a memorable phrase, the model was described as “a clock which strikes 13”. The UT rejected it as not a “reliable time piece”, and said it should not be put forward in future cases. (In appendix B the UT undertakes a detailed analysis of the other methodological challenges to the model.)
The future
Hedonic regression remains relevant though, for example, it is used in the Savills 2015 graphs (though the UT concluded that there are some technical issues to be addressed). But the Parthenia model is not to be used in future. Instead, one must examine the market at the valuation date and, where possible, gather comparable sales evidence of flats adjusted downwards to arrive at a value without rights. Reference might also be made to relativity graphs. The UT (in appendix C) sets out its conclusions on the usefulness or otherwise of the existing graphs, including those of Savills and Gerald Eve – though it did not give an unqualified endorsement of them.
Many would prefer a clear, simple prescriptive method to determine relativities for leases without rights. However, so far, one that commands support has failed to emerge.
