Question What is leasehold relativity and why is it causing so much fuss at the moment?
Answer Relativity is a component in the calculation of the premium payable in many instances of leasehold enfranchisement. It has assumed increasing importance in recent years. But the long-settled conventional approach to relativity has come under challenge. It remains to be seen whether this will prove successful. Three test cases are to be heard in the Upper Tribunal in January 2016: two involving flats on the Sloane Stanley Estate in Kensington, and another regarding a flat on the Wellcome Trust South Kensington Estate.
When a tenant enfranchises under the Leasehold Reform Act 1967 or the Leasehold Reform, Housing and Urban Development Act 1993, a premium is payable to the landlord. If the lease has an unexpired term of 80 years or less, the premium will include half of the “marriage value”. Marriage value is the extra value which arises when the value of a lease and its reversion are “married” together.
To calculate the marriage value one needs to know the value of the existing leasehold interest at the relevant date. For that, it is necessary to start with the property’s freehold vacant possession value and then to calculate what percentage of this the existing lease value represents. This proportion is referred to as “the relativity”. A lower relativity increases the marriage value and so increases the premium. If the property is particularly valuable, small changes to the relativity can represent substantial sums of money.
Relativity is complex because the Acts require the existing lease to be valued on the assumption that the tenant has no statutory right to enfranchise. This is sometimes referred to as “the no-Act world”, although in fact it is assumed that only the tenant’s lease cannot be enfranchised and not that other tenants in the market cannot do so.
This assumption creates problems because there are few real-world transactions with non-enfranchiseable leases. The market data relating to enfranchiseable leases is tainted by the effect of the Acts and – without any reliable data for comparison – any adjustment for the no-Act world is subjective and potentially arbitrary.
A number of surveyors’ firms drew up “graphs of relativity” to solve this difficulty. They attempted to express the relationship between the no-Act world value of leases of varying length and the unencumbered freehold value. Different graphs are based on different data, including settlements reached in enfranchisement claims, non-enfranchiseable sales and tribunal decisions, as well as the judgment and experience of those drawing them. These graphs have been used and endorsed in tribunal decisions, but they do not all yield the same results and using them requires an exercise of judgment. In Arrowdell Ltd v Coniston Court (North) Hove Ltd, LRA/72/2005, the Lands Tribunal observed that it should be possible to create standard graphs because the most important variable in any case will always be the length of the unexpired term. It invited the RICS to produce standard graphs and guidance on how to use them. The RICS set up a working party, which reported in 2009 but failed to produce a single standard graph, instead providing a selection of relativity graphs supported by various valuers’ firms at that time.
In 2011, economist Philippe Bracke started researching relativity. He analysed thousands of transactions from before 1993, when the leasehold enfranchisement regime was extended. He used an analysis method called hedonic regression to calculate the relationship between length of lease and value. His conclusions differed significantly from those in the conventional graphs of relativity, yielding a higher relativity, meaning a lower marriage value.
His research was relied on by the tenant in Kosta v The Trustees of the Phillimore Estate [2014] UKUT 0319 (LC); [2014] PLSCS 242. That was a claim to enfranchise a lease of a house in Kensington. The difference in the premium proposed by the tenant and that proposed by the landlord was almost £1m.
At first instance, the tribunal rejected the conclusions of the research. While it accepted that it was thorough and well argued, it had not been subject to peer review and was not supported by other valuation evidence. The tenant appealed, arguing that the methods used were unimpeachable and based on extensive market data.
The Upper Tribunal called Bracke’s work “a formidable piece of research” but ultimately rejected the tenant’s appeal. It was concerned at some unexplained and counterintuitive results and criticised the lack of conventional valuation evidence to act as a cross-check on the results. It also doubted the usefulness of the dataset – pre-1993 transactions – to a valuation many years later under different market conditions. But it criticised the landlords’ case as well, particularly their failure to support the methodology behind the graphs of relativity. Ultimately it left open whether a valuation based on the new research could prevail in another case.
Three such cases have now come before the Upper Tribunal. In each case the tenant is expected to rely on Bracke’s research, and the landlords will probably follow a more robustly analysed and supported selection of relativity graphs. These cases should hopefully provide comprehensive guidance for the future.
Jeremy Hudson is a partner in the property litigation team at Charles Russell Speechlys LLP and Tim Calland is a barrister at Enterprise Chambers
