The publication of the Law Commission’s Solutions for Houses paper has largely been driven by the trend among developers of selling houses on a leasehold basis with rent review clauses leading to onerous ground rents. So what exactly is the “solution” for leaseholders caught up in the leasehold houses ground rent scandal?
Illustrating the problem
The paper provides an example based on a lease of a house granted by Taylor Wimpey. House C has a freehold value of £400,000. It is let on a lease with an unexpired term of 241.5 years at a ground rent of £295 per annum which doubles on 1 January 2020 and every 10 years thereafter until 2060.
If the leaseholder of House C were to buy the freehold of the house pursuant to the Leasehold Reform Act 1967 now, the premium would be £60,763. While no marriage value would be payable, as the lease has more than 80 years left to run, and the value of the reversion is small (£5), given the length of the lease, the premium is high because of the value of the future ground rent income (£60,758).
As part of its work on enfranchisement, the Law Commission has been asked by government to consider options to reduce the premium payable while providing sufficient compensation to landlords.
The proposed solutions
To this end, the Commission puts forward a number of possible schemes: two simple formulae and two based on current valuation methodology:
■ 10 times ground rent: The first of the simple schemes is based on the proposal in MP Justin Madders’ private members bill that premiums should be 10 times ground rent. This would have the effect of reducing the premium payable for House C to £2,950.
While superficially attractive, this approach is largely arbitrary, even for the leaseholder of House C. In less than 18 months (and probably before any new legislation is enacted) that premium would rise to £5,900 and by 2030 to £11,800.
Such an arbitrary approach may well fall foul of human rights legislation.
■ Percentage of freehold value: The second simple formula is to take a percentage of freehold value, for example, 10%. Again, because this formula disregards the rent reviews, and, in fact, disregards the rent altogether, it would reduce the premium payable for House C (to £40,000).
However, as is exemplified in the paper, while the premium payable for House C will go down, the premium payable for a lower-value house, with a 130-year lease, and a fairly modest ground rent, £250, would substantially increase (from £4,051 to £20,000) suggesting that this formula is not the solution for all houses.
■ Ignoring marriage value: The first of the suggested schemes based on current valuation methodology is that marriage value would be removed from the calculation. This would be of no benefit to the leaseholder of House C, as, given the length of the lease, marriage value would not be payable in any event.
■ Simplifying valuation: The second such scheme is to prescribe some of the variables in the current valuation methodology: capitalisation rates, the deferment rate and relativity.
Primarily, this could simplify valuations, provide greater predictability as regards premiums and reduce disputes. However, as the Commission points out, the prescription of rates could also be used to reduce premiums. For the leaseholder of House C, who, currently, would not have to pay marriage value and would have to pay very little in respect of the reversionary value of the house, the prescription of relativity and/or the deferment rate would have little impact.
The prescription of a favourable capitalisation rate could, however, significantly reduce the premium payable. As the Commission illustrates, a one percentage point adjustment to the capitalisation rate could reduce the premium by over £20,000.
However, the resulting premium in the Commission’s illustration, £40,147, is still more than 10 times what the leaseholder would pay if the ground rent was fixed at £280 per annum.
By far the most attractive option for the leaseholder of House C would be one of the Commission’s suggested options for the treatment of ground rent in any statutory valuation.
The Commission suggests either that only one rent review is taken into account or that the ground rent is capped on review at 0.1% of freehold value, this being in line with Nationwide Building Society’s new lending policy.
Adopting the same capitalisation rate throughout, the premium payable would reduce to £12,697 (if only one review were accounted for) or £8,740 (if the ground rent were capped).
However, as the Commission points out, a higher capitalisation rate would be appropriate if there was only one review or the rent on review was capped, which would reduce premiums further.
Balancing interests
In addressing the need in its terms of reference to ensure that “sufficient compensation” is paid to landlords, the Commission notes the necessity of complying with human rights legislation.
While limiting the ground rent to be taken into account in any statutory valuation would bring significant benefits to those leaseholders caught up in the ground rent scandal, it need not affect the compensation payable to those landlords not accused of mis-selling.
In other words, such reform could avoid penalising the vast majority of landlords because of the mischief of the few.
Nonetheless, there is a risk that those landlords now holding reversions to leases with very high ground rents may challenge any reform which reduces premiums payable to them.
Those landlords (and affected leaseholders) will have an opportunity to respond to the Commission’s proposals once its consultation paper is published in September. However, it will ultimately be down to the government to decide if there is really a solution – and, if so, what that is.
■ For more detail on the paper see Residential leasehold and commonhold on the Law Commission website
Ellodie Gibbons is a barrister at Tanfield Chambers and is currently working part-time for the Law Commission
