Legal notes James Driscoll considers the application of different rates in short leases
Key points
• What should be the deferment rate to value short leases in enfranchisement claims?
• Is the possibility of an assured tenancy arising at the end of the long lease a relevant factor in valuing such claims?
• How should hope value be assessed?
One of the most contentious issues in recent leasehold enfranchisement claims has been valuation. The value of the landlord’s freehold vacant possession of the building has to be deferred for the remaining term of the remaining leases. What rate of compound interest should be applied to arrive at the value of the freeholder’s interest today?
Another valuation issue affects collective claims of blocks of flats. Should the fact that some of the leaseholders are not participating in the claim (and so not contributing to the marriage value payable) be accounted for in valuing the landlord’s interest and, if so, how?
The courts and the tribunals settled the fundamental elements of these issues in the celebrated Sportelli litigation (Earl Cadogan v Sportelli [2007] EWCA Civ 1042; [2008] 1 EGLR 137; [2008] UKHL 71; [2009] 1 EGLR 153):
? The Court of Appeal held that deferment rates of 4.75% for house lease claims and 5% for flat lease claims should usually be applied; and
? The House of Lords held that hope value can be claimed where there is evidence that a non-participating leaseholder might seek to negotiate a new lease.
These generic deferment rates should be applied for leases with more than 20 years unexpired. However, for leases with less than 20 years, a different approach is required, one that has regard to the property cycle at the time of valuation.
Short leases
What deferment rates apply where leases have less than 20 years unexpired and how should hope value be measured? In 2010, the Upper Tribunal (UT) considered cases of leases between 10 and less than 20 years in Cadogan Square Properties Ltd v Earl Cadogan [2010] UKUT 427 (LC); [2011] 1 EGLR 155. Based on its findings as to the property cycle at the various valuation dates in the claims, it applied a real growth rate of 1.75% for two valuation dates in 2005 and 1.5% for the valuation dates in 2007, rather than the 2% applied under the Sportelli guidelines. These conclusions produced deferment rates of 5.25% for the two 2005 claims and 5.5% for the three 2007 claims.
As in Sportelli, the UT stated that for leases with terms between 10 and up to 20 years unexpired, its general approach should be used in all such cases. For leases with unexpired terms of less than 10 years, its general approach should be the starting point, and for very short terms, using net rental yields as a guide to the deferment rate should be considered.
This left the deferment rate for leases of less than 10 years to be decided. This issue was recently considered by the Court of Appeal in Carey-Morgan v Trustees of the Sloane Stanley Estate [2012] EWCA Civ 1181. This concerned a 1920s mansion block within a conservation area in Kensington, London consisting of 25 flats, six with leases of 4.74 years remaining, 17 with unexpired terms of between 70 and 96 years and two flats to be lease-backed to the landlord (presumably flats not held under qualifying leases). Five leaseholders did not participate in the collective enfranchisement claim. Of these, one had an unexpired term of 70.25 years; the remaining four had just 4.74 years unexpired.
What should be the deferment rate for such short leases? Also, hope value was clearly payable, but on what principles?
Deferment
The nominee purchasers appealed the UT’s decisions on the applicable deferment rates for the shorter leases and on hope value. On appeal, the nominee purchaser raised a new issue: the UT was wrong, it submitted, to base its decision on the assumption that the landlord would have vacant possession on the expiry of the four very short leases. It might not, as any of those leaseholders could exercise their right to an assured tenancy and continue in possession under schedule 10 of the Local Government and Housing Act 1989 (the 1989 Act).
In such cases, the landlord would not be entitled to early vacant possession, and the normal Sportelli deferment rate should apply. As this had not been raised in the UT proceedings (where, if accepted, it would have required additional evidence and submissions) the court rejected this as a ground of appeal.
The court endorsed the approach taken by the UT, which was to apply a deferment rate based on net rental yield and an end allowance of 5% off the vacant freehold value. This gave a deferment rate of 4.73% to be applied in the case of such short leases. However, the court declined to use this as a guideline for future cases as there may be circumstances where, unlike this one, the parties raise an issue as to whether a tenancy may arise at the end of a short lease. In addition, there remains some uncertainty over the deferment rate for leases with unexpired terms between five and 10 years.
Hope
Concerning hope value, the Court of Appeal upheld the approach taken by the UT in considering evidence of patterns of applications for new leases in the premises and having regard to its own previous decision on hope value in Culley v Daejan Properties Ltd [2009] UKUT 168 (LC); [2009] 3 EGLR 165. As a result, the decisions in Carey-Morgan were correctly decided: hope value at 20% of marriage value for the shorter leases and 10% for the one longer lease, expressed as a percentage of overall marriage value (as opposed to a percentage of the landlord’s share).
Whether a leaseholder will have an assured tenancy at the end of the lease currently depends on whether the rent is below £25,000 pa. This is the upper limit specified in the 1989 Act, which is unaffected by the increase in the maximum rent for assured tenancies to £100,000 in amendments to the Housing Act 1988. The government has consulted over whether the 1989 Act limit should be increased, see DCLG: Updating Leasehold Value Limits – Consultation: Summary of Responses, February 2012. Increasing the limit may well result in more flats in the more expensive parts of London and elsewhere becoming eligible for an assured tenancy at the end of the long lease.
Common sense suggests that leaseholders with very short leases are more likely than not to seek a new lease before expiry of the term. However, the hypothetical purchaser in cases such as Carey-Morgan, who has the prospect of possession in less than five years, and who can then choose to live in the flat, let it at a market rent, or renovate and sell on a long lease will presumably “hope” that the leaseholder will not seek a new lease; or if they do, would refuse to grant it.
Professor James Driscoll is a solicitor and a mediator
