Leasehold enfranchisement – House – Price payable – Leasehold Reform Act 1967 – House converted into bedsits and let to students – Whether freehold value to reflect prospect of planning permission for use as single residence – Whether deferment rate should start at 4.75% rate for houses or 5% rate for flats – Whether further adjustments to deferment rate justified – Proper treatment of deductions for restrictive covenant and statutory tenancy of room – Appellant’s appeal allowed – Respondent’s appeal dismissed
The appellants applied, under the leasehold enfranchisement provisions of the Leasehold Reform Act 1967, to acquire the freehold of a 1880s mid-terrace property in London of which they held a long lease. Although originally built and occupied as a single house above a basement, raised ground and four upper-floor levels, the property had subsequently been rearranged as two self-contained basement flats with the remainder used as bedsits and ancillary accommodation. At the valuation date of May 2006, the appellants occupied the rear basement flat, while a statutory tenant occupied one other room in the property and an American university rented the front basement as its administrative offices. The remainder of the property was sublet to a company that had, for at least 10 years, made an annual arrangement with the university for students to occupy it from October through to June.
The leasehold valuation tribunal (LVT) determined the price payable for the freehold at £883,995. In doing so, it applied the generic 4.75% deferment rate for houses as laid down in Earl Cadogan v Sportelli [2007] 1 EGLR 153. It also made a £50,000 deduction for the statutory tenancy and a further deduction of £50,000 in respect of a restrictive covenant against trade or business use, to which the freehold interest to be acquired by the appellants was subject.
The appellants appealed on the issue of the freehold value and the deferment rate, contending for a price of £553,169. The respondent also appealed, contending for a price of £1.076m. The appeals centred on whether the property should have been valued with its permitted use as a hostel or house in multiple occupation (HMO), rather than any potential Class C3 use as a single house, and whether the Sportelli deferment rate for houses was appropriate where residential planning permission might not be forthcoming. An issue also arose concerning the stage in the valuation process at which the £50,000 deductions for the restrictive covenant and the statutory tenancy should be made.
Held: The appellant’s appeal was allowed; the respondent’s appeal was dismissed; an enfranchisement price of £606,861 was determined.
(1) At the valuation date, the use of the upper parts of the property was as a hostel or HMO and the policy of the relevant local plan was to resist the loss of hostels and HMOs and their conversion into Class C3 self-contained accommodation safe unless certain conditions were met, including the availability of a land swap to provide another hostel or HMO elsewhere. On the evidence, a prospective purchaser of the property would have taken the view that the likelihood of obtaining residential planning permission were good provided that a land swap was available. Such a purchaser would take into consideration how much such a land swap might cost. The uncertainty as to both the prospects and the total cost of obtaining planning permission for Class C3 use, and the size of the adjustment required to reflect the different planning status of the appeal property and the only Class C3 comparable offered by the parties, rendered that process of comparison unreliable. Consequently, the most reliable method of valuing the property was as an existing hostel by reference to the sales of other properties in the area that were in HMO use, which prices would have reflected such hope as existed for obtaining consent for Class C3 use in the future.
(2) A departure from the 4.75% Sportelli deferment rate for houses was justified by the circumstances of the appeal property. The higher rate of 5% for flats, reflecting their greater management problems, was equally applicable to the appeal property. The work involved in maintaining the property in repair and subletting it to occupiers every year was clearly management-intensive. The characteristics of the appeal property compared more closely with flats than with a single house.
A further increase above 5% was justified for the lower prospects of capital growth for the appeal prospect, when compared with houses and flats. The risk premium could be changed to counterbalance any adjustment to the growth rate where prices achieved in the market were above or below the long-term trend level. The evidence showed that the values of buildings with HMO or hostel use had grown substantially less than C3 residential units over a lengthy period. In light of the unchallenged evidence that the value of the appeal property had grown at a rate far below that for flats and houses in the vicinity over the previous 50 years, a potential investor would be concerned that the 2% real growth rate assumed as a component of the 5% Sportelli might not be achieved from an investment in the appeal property. That concern would be reflected in a 0.5% increase in the risk premium, increasing the deferment rate to 5.5%. The deferment rate should not reflect the prospect that a change of use to Class C3 would increase the freehold value substantially; that would involve double counting since the prospect of such increase was already reflected in the existing freehold value as hope value.
No further adjustment to the deferment rate was required for obsolescence. Although the notional purchaser was buying subject to the sublease but without the benefit of any tenant’s repairing covenants, it would consider that the occupants under a sublease would maintain the property in satisfactory condition for their own purposes, so as to generate income from hostel use and comply with the terms of any HMO licence. Accordingly, the overall deferment rate was 5.5%.
(3) Since the discount of £50,000 for the restrictive covenant represented the anticipated cost of discharging or modifying that covenant, the stage at which it fell to be taken into the valuation calculation depended on whether the hypothetical purchaser would expect to have to spend that sum at the date of acquisition of the property or at the term date when freehold possession reverted to it. The hypothetical purchaser would consider that the party with the benefit of the covenant was unlikely to seek to enforce it, when it had not objected to its breach for many years, or in establishing liability on the part of the purchaser if it did. Accordingly, the hypothetical purchaser was more likely to deduct the £50,000 from the value of the freehold that would revert to it at the term date, on the basis that it was then, if ever, troubled by the restrictive covenant, than to deduct it from the price actually paid, since the latter would be appropriate only if it had to buy out the covenant immediately after purchase. Consequently, the discount for the restrictive covenant should be made from the value of the freehold that fell to be deferred, rather than from the final figure that would otherwise be payable as the enfranchisement price. With regard to the statutory tenancy, this would affect the value that the hypothetical purchaser would attribute to the freehold reversion and would result in a significant reduction, which, as assessed by the LVT, was £50,000.
Edwin Johnson (instructed by David Conway & Co) appeared for the appellants; Kenneth Munro (instructed by David Greenberg & Co) appeared for the respondent.
Sally Dobson, barrister
