Jeremy Hudson and Jennifer Meech assess the practical implications of a recent high-profile Court of Appeal decision on premiums payable for new leases
Question: I am valuing the premium payable for a new lease of a flat pursuant to the Leasehold Reform, Housing and Urban Development Act 1993 (the Act). When calculating marriage value the Parthenia model would have been very beneficial to my client as tenant, but the Upper Tribunal (Lands Chamber) (UT) rejected it in Trustees of the Sloane Stanley Estate v Mundy [2016] UKUT 223 (LC); [2016] EGLR 38. I am aware that the decision was recently appealed. Was the Parthenia model vindicated and, if not, what guidance has been provided for calculating leasehold relativity?
Answer
The Court of Appeal in Mundy ([2018] EWCA Civ 35; [2018] EGLR 7) decided that the UT had been right to reject Parthenia and held that, in the absence of a more reliable, simpler model, the calculation of leasehold relativity is a matter of valuation judgment. Your correct starting point is the market value of the flat in the real world, from which you make an appropriate discount to reflect the statutory assumption that the flat and the building in which it is situated are outside the Act, possibly using valuation graphs as a cross-check.
Explanation
Under the Act a premium is payable to the landlord in return for a 90-year lease extension. If the tenant’s existing lease has an unexpired term of 80 years or less, the premium will include “marriage value”. Mundy is about the way in which marriage value should be assessed.
Marriage value is calculated by ascertaining the difference between (i) the value of the tenant’s current lease together with the value of the landlord’s interest in the flat prior to the extension, and (ii) the value of the tenant’s new lease together with the value of the landlord’s interest once the new lease has been granted. This requires the existing lease to be valued on the assumption that the tenant has no right to extend under the Act.
The relationship between the value of the leasehold interest in the real world and the value of the same interest in the so-called “no-Act world” is known as “relativity”. A lower relativity increases the marriage value and so increases the premium payable. If the property is particularly valuable, small changes in relativity can represent substantial sums of money. There is no simple way of calculating relativity. Were there to be a reliable and simple model or graph, this would be a “holy grail”, in the words of the Court of Appeal in Mundy.
The authors of the Parthenia model thought that they had designed a model which would accurately calculate relativity. The model was based on a statistical technique called hedonic regression analysis, using information derived from pre-Act transactions, with the objective of eliminating the effect of the Act on relativity. The UT in Mundy, however, rejected the Parthenia model as “a clock which strikes 13”. In one case considered by the UT a lease (with statutory rights) having a market value of £2m was found by the model to have a no-Act value of £2.3m. It was accepted by all parties that Act rights must have value. Therefore the UT concluded that this was an impossible result and that accordingly the model must be incorrect.
One tenant appealed against the UT’s decision arguing that “the comparison between the value of the lease in the real world (with rights under the Act) and the value of the lease without such rights as shown in the Parthenia model was an illegitimate comparison”. The tenant argued that the statutory assumptions preclude one from “having regard to any leasehold transaction in the real world where the lease attracts rights under the Act”.
The Court of Appeal dismissed that argument. Lewison LJ considered that the UT had been perfectly entitled to reject the Parthenia model on the basis of the evidence adduced. He then went on to analyse the true nature of the no-Act assumption. The starting point laid down by the Act is an assumption of a sale in the open market: “…things are to be taken as they are in reality on the valuation date, except to the extent that the instrument postulating the hypothetical transaction requires a departure from reality.” In the opinion of the court there was nothing in the statutory assumption “that forbids a valuer from looking at transactions in the real world in order to assist in determining value on the required assumptions”. By comparison, in the field of commercial leases, it was “commonplace” for valuers to make adjustments to reflect that tenants might or might not enjoy the protection of Part 2 of the Landlord and Tenant Act 1954. There was no reason why it should be difficult for valuers to make similar adjustments when valuing under the Act.
Another point of contention in Mundy was the extent of the “no-Act world” for the purposes of analysing relativity. The court rejected the argument that the no-Act assumption should relate to the whole world (ie a world in which no flat has any rights under the Act). Instead the court asserted that the assumption only covers the building in which the flat is situated.
In the UT there was considerable discussion and evidence about the value of relativity graphs. The UT found itself unable to give unqualified endorsement to any of the graphs currently in the market. Be that as it may the Court of Appeal recognised that these graphs could be used as a “cross-check”, which is what the UT had done. The tenant had argued that the market itself had been “corrupted” by the “industry standard” Gerald Eve graph, but Lewison LJ said this was an “overstatement”, adding: “The market may not be perfect but it is still the market”.
Unless and until the Law Commission comes up with a simplification of valuations under the Act, which obtains government approval, valuers will have to exercise their judgment as best they can.
Jeremy Hudson is a partner at Charles Russell Speechlys and Jennifer Meech is a barrister at Enterprise Chambers
