Reversion value on a block of flats fails to account for appreciation using normal calculations. But a solution exists, explains Martin Ward
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Key points |
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● The current method of calculating the freehold reversion value of a block of flats wrongly assumes that the property will not appreciate in value during the remainder of the unexpired lease term ● Two solutions exist to rectify the problem |
Criticism has mounted of the valuation determinations by the Leasehold Valuation Tribunals (LVT) when settling disputes between freeholders and lessees about the price to be paid for a freehold or lease extension. There have been suggestions that LVT decisions are pro-tenant and that decisions are typically closer to tenant valuations.
It has been claimed that “valuation is an art, not an exact science” and is over-reliant upon a surveyor’s “rule of thumb”. Freeholders, who are often compulsorily relieved of up to hundreds of thousands of pounds, might be comforted if they felt that the compensation process involved more modern science supported by rigourous logic.
The Commonhold and Leasehold Reform Act 2002 stipulates that in leasehold enfranchisement cases, where the unexpired term of the lease exceeds 80 years, the marriage value shall be taken to be nil. Nevertheless, the Act can still provide for full and fair compensation where the remaining two elements are correctly valued. These two are:
● the “term” – the future payment stream of ground rents; and
● the “reversion” – the value ascribed to the flat or house representing the price for which it could be sold when the current term expires.
This short article covers only the more serious “freehold reversion” valuation weakness by reference to a valuation illustration extracted directly from the www.lease-advice.org.uk website.
Valuation weaknesses in practice
Assume that a block of 10 flats has unexpired leases that total 68 years. The ground rent of each flat is £50 pa and the individual market value of each flat with its existing lease is taken as £150,000. The current value of the flats is £150,000 x 10 flats = £1,500,000 – the leaseholders’ present interest.
For the purpose of the calculation of the reversion, a value must be ascribed to the flats representing the amount at which they could be sold when the current term expires. For this purpose, it must be assumed that the most favourable leases will then be granted to maximise value – a 999-year term.
We assume that the acquisition today would produce an increase in the market value of the flats equivalent to 10%, representing a future – in fact, present – value of each flat of £165,000. Thus, the improved (present) value is £165,000 x 10 = £1,650,000
Again, a multiplier is taken from the tables to provide an investment value. What is the promise of the future £1.6m worth today? The multiplier, the present value of £1, is taken at the same yield rate, 8%, as previously. So, the present value of £1 deferred 68 years at 8% is 0.00534, and £1,650,000 x 0.00534 = £8,811.
The calculations: key observations
●The example correctly explains that “a value must be ascribed to the flats representing the price for which they could be sold when the current term expires” — the future value. But no attempt has been made to allow for any growth in the value of the properties over the next 68 years from the present value of £1,650,000 — an obvious and fundamental error. It has been wrongly assumed that, after 68 years, the property will still be worth the same as it is today.
● The example then proceeds to derive a present value by applying 68 years of discount to a figure that is already today’s present value, that is, £1,650,000.
The flaws in this example can be overcome in one of two ways.
●Provide a fair and realistic projection of the future value of the “improved” block of flats by incrementing the present value of £1,650,000 by, perhaps, historic experience of past growth rates – many sources are available – to provide a realistic future value for discounting.
● Replace the 8% nominal (non inflation-adjusted) yield with a real yield (inflation adjusted or index-linked – see below). This can then be fairly applied to discount the present value figure of £1,650,000.
An appropriate “real yield”, adopted and endorsed by the government, would be the rate published by HM Treasury in its April 2003 Green Book recommending a real yield of 3.5% pa for valuing existing assets or for any decisions to sell land or other assets. The previous Green Book, 1997, mandated the “nom-inal” (non-RPI) 6% rate that has also been used by the LVT for many years. This guidance is binding on all government departments and executive agencies and is used widely by local government.
The judgments flowing from the five “Grand Assize” cases, expected soon from the Lands Tribunal, should help to inform the debate on honest and realistic reversion yields.
Martin Ward is a chartered certified accountant
