Jeremy Hudson and David Peachey discuss a recent ruling concerning the calculation of premiums for residential lease extensions
Question
What did the Upper Tribunal (“UT”) decide in the recent case of The Trustees of the Sloane Stanley Estate v Mundy [2016] UKUT 223 (LC); [2016] PLSCS 138 and why?
Answer
The UT rejected the “Parthenia model”, relied on by tenants when calculating premiums for residential lease extensions under the Leasehold Reform, Housing and Urban Development Act 1993 (“the Act”). The model led to a nonsensical result in the instant case and should no longer be used.
Explanation
The premium for a lease extension under the Act is calculated using various factors, including, where the remaining term of the lease is less than 80 years, the marriage value. This is calculated by taking the value of the extended lease and subtracting the value of the existing lease, the latter being subject to the fictional assumption that there is no right to apply for an extension under the Act.
There has been much litigation based on how to calculate the existing lease value relative to market values (“relativity”). The usual method of calculating a property’s value (using market comparables) is made difficult where all the comparables available necessarily benefit from the right to apply for an extension. This caused much argument over how this relative “no-Act” value should be calculated.
Tenants argue for a higher value of the existing lease: a lower-value lease would increase the differential between it and the (easily ascertainable) extended lease value. Landlords, however, argue that the value of an existing lease should be lower, to increase the differential and, therefore, increase the marriage value part of the lease premium.
The Parthenia model used pre-Act data to carve out the market forces which affect the value of a leasehold; specifically, the part which applies to the right to an extended lease (which right did not exist pre-Act). This means that the data is around 25 years old. In Sloane Stanley Estate, the open-market value of the leasehold property was £2m. The tenant’s use of the Parthenia model led to a “no-Act” value of £2.3m.
This, the UT held, made no sense. Rights under the Act have financial value, so the market value with those rights must be higher than the fictional “no-Act” value. The fact that the Parthenia model led to such an obscure result in one case meant that it should be disregarded in all cases. The UT relied instead on the landlord’s method of calculating relativity, applying a reduction of 10% to the market value of the property to come to a value of £1.8m. Producing a lower value, this method gave a larger differential, making the tenant’s premium significantly greater than it would have been had the Parthenia method been adopted. The decision is good for landlords, and bad for tenants.
Question
Did the UT give guidance as to how leasehold relativity should be determined in future cases?
Answer
The UT declined to lay down any definitive test, but stressed the importance of expert valuers’ analysis of available market evidence, potentially assisted by a new graph of relativities.
Explanation
In Sloane Stanley Estate the UT said it would have liked to arrive at a method of valuation which would be “clear and simple and predictable as to its future application to determine the relativities for leases without rights under the 1993 Act”. The only certainty that resulted from this decision was that the Parthenia model was not to be used in future. Absent an alternative suitable model, the UT provided some guidance as to those matters which it said might be of use in future cases.
First, tribunals and valuers have to focus on the actual market evidence at the relevant date of claim. The fact that the market might have been badly informed or operating illogically or inappropriately was not a reason for ignoring that evidence.
Second, the UT noted that markets change and may perform differently in the future from the way they have performed in the past. Therefore, evidence of past performance is not always conclusive.
Third, an actual market transaction involving the existing lease with rights under the Act is likely to be “a very useful starting point for determining the value of the existing lease without rights”. It would then be for an experienced valuer “to express an independent opinion as to the proper amount of the deduction which would be appropriate to reflect” the absence of rights.
Last, in the absence of a market transaction, valuers may have to adopt more than one approach. In this context the use of a reliable graph may assist the process. If the various methods throw up different figures then it is up to the valuer to make a judgment as to which is to be preferred.
Much time was spent over the nine-day hearing discussing graphs. Have graphs had their day as a result of this decision? On the contrary, the UT thought that an up-to-date graph based on contemporary market evidence could be helpful to valuers and tribunals in future cases. Savills has recently produced modernised graphs and tables based on nearly 6,000 sales of leasehold flats, analysed using the hedonic regression method. It remains to be seen whether tribunals and valuers will decide that this does indeed provide the “clear and simple” solution sought after by the UT.
Jeremy Hudson is a partner at Charles Russell Speechlys and David Peachey is a barrister at Enterprise Chambers
Questions on any topic can be e-mailed to egq&a@crsblaw.com and egq&a@enterprisechambers.com
