Leasehold Reform, Housing and Urban Development Act 1993 – Lease extension – Purchase price – Whether departure from 5% deferment rate in Sportelli v Earl Cadogan [2007] 1 EGLR 153 justified for flat in Shepherd’s Bush – Appropriate relativity percentage to be applied to find value of lease compared to freehold – Appeal dismissed
The first-tier tribunal (FTT) was asked to determine the price payable by the appellant leaseholder to the respondent landlord for the grant of an extended lease of a flat in Shepherd’s Bush, London W12, pursuant to Chapter II of Part I of the Leasehold Reform, Housing and Urban Development Act 1993. The appellant’s flat was the upper of two flats in a converted Victorian terraced house. It was held on a long lease at a low rent, of which 72.167 years remained unexpired at the valuation date in October 2013.
In calculating the price payable, the FTT found that the value of the freehold with vacant possession was £653,250. It applied a deferment rate of 5%, in line with Earl Cadogan v Sportelli [2007] 1 EGLR 153, to calculate the value of the reversion as at the valuation date to reflect the fact that the right to vacant possession arose only on the expiry of the current lease term. In doing so, it rejected the figure of 5.75% which the appellant had suggested was appropriate to reflect differences between the W12 postcode area and the prime central London (PCL) area considered in Sportelli. The appellant had contended that an additional 0.25% should be added for the risk of obsolescence, a further 0.25% for the increased risk of investment in the W12 postcode area and a final 0.25% for the increased burden of administration. The appellant argued that those risks were not reflected in the open market value of the flat beyond the 11 years which an occupier purchaser, as opposed to an investor in the reversion, would be expected to keep the flat; he submitted that guidance on risk levels for years 12 to 72 could be derived from an examination of the market in gilt-edged securities.
The FTT further decided that a percentage of 91.4% should be adopted for relativity, to represent the value of the unexpired lease term as a percentage of the freehold value. In doing so, it relied on the relativity graphs contained in the RICS Research Report “Leasehold Reform: Graphs of Relativity” (October 2009). The appellant had contended for a relativity of 96%, based not published graphs of relativity but on the calculations and graphs prepared by his expert witness. Overall, the FTT determined that the purchase price should be £39,000.
The appellant appealed in relation to the deferment rate and relativity.
Held: The appeal was dismissed.
(1) The FTT had not given clear and sufficient reasons for rejecting the appellant’s case and accordingly its decision could not stand. However, after considering the matter afresh, the Upper Tribunal reached the same conclusions as the FTT on the deferment rate and relativity.
(2) The appellant’s analysis of risks wrongly assumed that a purchaser who was purchasing the 72-year reversion as an investment would be required, or would choose, to hold it for the full 72 years, as opposed to an occupier purchaser who, on the appellant’s assumptions, would sell after 11 years. That was a false distinction since an investor in the reversion could also sell it and tradeability would be an important component of owning the 72-year reversion. One reason why the volatility of the housing market and the relative liquidity of the investment were significant factors in the assessment of the risk premium element of the deferment rate was that the investor purchaser would be concerned to possess an asset which was tradeable. So far as the appellant contended for an uplift to the risk premium to reflect risks that were not allowed for in the open market value of the flat after the 11th year, his analysis was to be rejected. Even an occupier purchaser who notionally had it in mind that he was purchasing for about 11 years of occupation would be concerned about the future prospects after that time since they might affect the price that he would obtain when in due course he sold the flat.
Further, an examination of the market in gilt-edged securities, in the manner undertaken by the appellant, was not useful as a guide to any additional level of risk attributable to holding the freehold reversion for years 12 to 72. The investor in the freehold reversion would possess a freehold subject to a lease which would end in 72 years’ time. Such an investor would have an investment which in principle should keep up with inflation and generate 2% growth, but with a risk of that not happening, which was allowed for in the risk premium. By contrast, the gilt-edged investments to which the appellant referred were investments which conferred the prospect of getting precisely a certain number of pounds in a certain number of years’ time; there was effectively no risk of not getting that return. The yield that would be required by someone buying such an investment now, with a view to a fixed return in a future year, would be substantially driven by the view that the investor would take on long-term interest rates and prospects of inflation. Neither of those two matters were of central importance to the purchaser of the 72-year reversion.
Moreover, as regards the risks identified by the appellant, the Shepherd’s Bush area was much improved compared with the middle of the last century and there was no reason for an investor to detect any extra risk, as compared with PCL, that that area of London would deteriorate between years 12 and 72. Nor was there any evidence to suggest that an investor would be more concerned about risk of obsolescence for the appellant’s flat than for a property in PCL. The evidence showed that money spent on building or rebuilding a property in the area of the appellant’s flat was well spent and was reflected in a stable or rising value; therefore the risk of necessary work not being done, and the property being allowed to deteriorate and become obsolete, was not significantly greater than in PCL. Overall, there was no reason to depart from the 5% deferment rate indicated in Sportelli, which was supported by the respondent and which the FTT had adopted in its decision.
(2) Although the appellant’s expert had spent a lot of time and effort producing data for sales of leases with a range of unexpired terms from 65 to 190 years in the W12 postcode area, he had produced no evidence of freehold values. Accordingly, his dates were not relativity graphs since they lacked the necessary comparison between leasehold and freehold values. His analysis of flat transactions in the local area was not of assistance in determining the relativity and was deficient in certain respects. First, he had indexed prices over long periods of up to 20 years, which was not an inappropriate approach to take, particularly over periods where the market was volatile or showing extreme price movements. Second, he assumed that the large number of transactions in his analysis would ensure that the best fit regression line would take account of differences in the state of repair of individual properties, with flats that had deteriorated cancelling out those that had been improved. His analysis therefore failed to show whether, for any given pair of transactions of a flat, the price change was due in part to the specific improvement or deterioration of the property. A more specific analysis and a more detailed knowledge of the individual properties would be required before the results could be considered robust and reliable.
A “further test” adopted by the appellant’s expert for determining the relativity was also defective so far as it compared the year’s purchase for 72 years at 5.6% to the year’s purchase in perpetuity at the same rate. The expert’s rationale was that the purchase of a lease on a nominal ground rent was, in principle, the acquisition of a substantial profit rent which could be capitalised at the deferment rate appropriate for the length of the lease. However, the expert had made no attempt to test his model against empirical data; consequently, it was simply an untested conjecture and had no validity. Moreover, the expert had made no attempt to rationalise his adoption of the deferment rate as the appropriate remunerative rate; he simply adopted the deferment rate. Finally, he had assumed that the notional profit rent was constant, which would not necessarily be the case as the length of lease reduced and the security of tenure declined. For those reasons, the theoretical model of the appellant’s expert was not reliable and should be given no weight: Nailrile Ltd v Earl Cadogan [2009] RVR 95; [2009] 2 EGLR 151 applied.
The appellant’s flat was not in, but was close to, PCL. It was appropriate to calculated the relativity by reference to the Cluttons PCL Graph, which had the benefit of a separate graph for flats and which covered areas close to the appellant’s property, notwithstanding that the graph was based on settlement evidence which was normally of no assistance: Arrowdell Ltd v Coniston Court (North) Hove Ltd [2007] RVR 39; [2013] PLSCS 278 considered. Since the figures in the graph compared well with those in other PCL graphs which were based at least in part on transactional evidence, it was reasonable and representative to use the Cluttons PCL graph when assessing the relativity of the appellant’s flat. It was also appropriate to refer to the Nesbitt & Co graph, which had the advantage of being based predominantly on data for flats in Greater London and the outer suburbs but the disadvantage of being based on settlements. To help overcome the problem of the use of settlements, reference should also be made to the South East Leasehold graph, which was based on transactions of flats with an even balance between acting for tenants and landlords. Taking the relativity figures from those graphs, and producing weighted average to reflect the fact that the appellant’s property was outside PCL, resulted in a relativity of 91.4%, which was the figure adopted by the FTT.
The only amendment to be made to the price determined by the FTT flowed from the fact that it had erroneously applied the relativity to the long leasehold value rather than the freehold value. After correcting that matter, the price payable was £37,545.
Colin Hurst MRICS, of Colin Hurst & Partners, appeared for the appellant; Paul Harper LLB (Hons), of Collingwoods, appeared for the respondent.
Sally Dobson, barrister
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