Leasehold Houses – Valuation for enfranchisement

Introduction

This leaflet is not meant to describe or give a full interpretation of the law, as only the courts can do that. And it does not cover every case. If you are in any doubt about your rights and responsibilities, you should get advice from a solicitor who specialises in this area of the law.

If you are considering enfranchising (buying) the freehold of your leasehold house, you will probably begin by asking ‘How much will it cost?’ The valuation process required by the law is complicated, so it is often difficult to form a clear view of the price at the beginning of the process.

This advice note aims to describe:

• the rules for calculating the valuation;
• the way in which the price is assessed; and
• the role of the professional adviser in the process.

This note is not intended as a ‘do-it-yourself’ guide to valuing your own freehold. You should get professional advice as early in the process as possible.

The law

The Leasehold Reform Act 1967 (the 1967 act) gives leasehold tenants (leaseholders) of houses the right to buy the freehold. The right to buy the freehold is called ‘enfranchisement’. Some freeholders (landlords) will sell the freehold without the leaseholder needing to make a formal claim, but whether you make a claim or not, you should get professional advice to find out roughly what the whole process will cost.

Because the basic right has been extended over the years by various amendments made to the 1967 act, the rules for calculating the price are complicated.

The two valuation methods

The 1967 act provides two distinct methods for valuating houses under the act. These are generally referred to by the relevant section of the 1967 act, as follows.

Section 9 (1) – the house will be valued according to the original valuation basis, that is, the value of the site.

Section 9 (1A), 9 (1C) – the house will be valued according to the special valuation basis, that is, the value of the house, including a share of the marriage value.

You and the landlord cannot choose which valuation to use. It depends on the qualification criteria.

Put simply:

• if the lease meets the original low-rent test and the house meets the value limits, the house will be valued according to the original valuation basis under section 9 (1) of the 1967 act; or
• in all other cases, including cases where the original lease had been extended under section 14 of the 1967 act, the house will be valued according to the special valuation basis.

Generally, if a house is valued using the special valuation basis of assessment, the price is much higher than it would be under the original valuation basis, so it is very important to work out which valuation method should be used.

By law, under both sets of rules, the freehold must be valued as if it were being sold on the open market by a willing seller to a willing buyer. The principles of the 1967 act are not to provide a forced bargain for the leaseholder, but to adequately compensate the landlord for the loss of their property by making sure the leaseholder pays a fair price, based as closely as possible on open-market values. It is difficult to assess an open-market value in the artificial situation created by the need to protect the leaseholder’s rights.

If you and the landlord cannot settle the price by negotiation, either of you can ask a First-tier Tribunal (Property Chamber) to settle the matter. The tribunal’s role is not to decide in favour of either your or the landlord’s valuation, but to make an independent decision. So, the tribunal’s decision may not necessarily reflect either of the prices you or the landlord proposed.

As the leaseholder, you start the process of enfranchisement by serving a formal notice of claim to tell the landlord that you plan to use your right to buy the freehold. Once you have served this notice, you will be liable to pay the landlord’s reasonable costs in dealing with it, so you should find out what these costs are likely to be before you begin the process. A valuation surveyor experienced in the law and with a good knowledge of the local property market will be able to help you.

Gathering information

You will need professional advice to confirm your rights and which valuation method should be used.

You will need to gather a certain amount of information, and a professional adviser will be better able to help you if they have the relevant information to hand. The following checklist of the information you will need should be useful.

Details of the lease

• The date of the lease, or the start date if this is different (this is the date of the original lease, and is not always the same as the date on which you took over the lease).
• The amount of the original ground rent that was charged at the start of the lease, if any.
• The amount of any premium (price) included in the lease.

All this information should be on the first page of the lease document. If you do not have the lease, you will need to get a copy from your mortgage provider, your solicitor or whoever holds it. You may also be able to get a copy of the lease from the Land Registry.

Rateable values

You will need the rateable value of the house on:

• the first day of the lease (if it had one), or on 23 March 1965, whichever is later; and
• on 31 March 1990.

You may be able to get this information from your local authority or water company, if you are not on a water meter.

The original valuation basis (site value)

The original reasoning behind the 1967 act was that the landlord owned the land but the leaseholder owned the house. So, at the end of the lease, the landlord would be left with a vacant piece of land which they could let at a ‘modern ground rent’.

The reality is, of course, rather different but the principle remains the same – to assess today’s value of the land the house stands on in terms of the ground rent the landlord could receive at today’s rates.

The 1967 act provided a different approach to this, based on the leaseholder’s legal right to a new lease. It gave leaseholders the right to extend the lease by 50 years, from the date the current lease ends. The ground rent for the new lease would be assessed on the first day of the new lease as a proportion of the value of the land (the site value), and would be a modern ground rent. (A modern ground rent is usually much higher than the existing ground rent.)

This valuation procedure will assume that the leaseholder takes up their right to the 50-year extension at the modern ground rent. So the landlord’s interest becomes the right to receive the rent and any increased rent during the term of the lease (‘the term’), followed by the right to receive a modern ground rent for 50 years (‘the first reversion value’), followed by the right to vacant possession of the house at the end of the lease (‘the second reversion value’). It is called the reversion because it refers to the time when the house reverts (returns) to the landlord.

Example

The original valuation procedure can be illustrated by an example using the following assumptions.

• A house has 28½ years left on the lease, a fixed ground rent of £6.25 a year, and an estimated freehold vacant possession value of £160,000. (The estimated freehold vacant possession value is an estimate of what the value of the house would be if it was purely freehold and not subject to any leasehold interests.)

Calculating the term (the rent the landlord is expected to receive over the life of the lease)

The freehold interest in a house occupied by a leasehold tenant is an investment. The landlord’s money is tied up in the ownership of the house and, in return, they receive rent.

The rent, divided by the value of the interest, is called the yield. This is a similar concept to the interest received on money in a building-society account – the rate of interest an investor receives on their money is also the yield. If building societies are offering accounts with a yearly interest rate of 10%, the account earns 10% interest on the money invested. Investors look at the interest earned on a property value in much the same way, and what they are prepared to pay for a property depends on the yield they are hoping to receive. The valuer will use their knowledge and experience of the investment market to work out the yield the landlord could expect to receive for the rent the leaseholder will pay under the lease. They will calculate the value of the landlord’s interest during the term of the lease by multiplying the rent by the yield for the remaining term of the lease (the yield will be shown in valuation tables as ‘years purchase’). For this example, the yield is assumed to be 6.5%.

The ground rent is £6.25 per year.

Years purchase for 28½ years at 6.5% (from valuation tables) is 12.83.

So, the term is £6.25 x 12.83 = £80

The calculation provides a figure which represents compensation to the landlord for the rent they will lose over the remaining period of the lease. So, £80 is taken as the value (at today’s prices) of the landlord’s right to receive £6.25 a year for the next 28½ years. It is not correct just to multiply the ground rent by the remaining years of the term.

Calculating the first reversion value

The next step will be to calculate the modern ground rent. The whole valuation is carried out at the date of the leaseholder’s claim and values are not projected forward in time. This means that the valuer is looking for the value of the land on which the house stands on the date of the notice of claim that the leaseholder gives to the landlord. There is rarely any evidence available of sales of individual plots of land, so the only way of deciding the value of the land is to look at it as a percentage of the value of the house. The valuer will have to assess the value of the house on a freehold basis, assuming there is vacant possession and that the house has been developed to its full potential.

Having valued the house, the valuer will use their local knowledge and experience to work out what percentage of that value will apply to the cost of the land (the site value). Depending on the location and nature of the house (for example the size of any garden and whether the house is on a corner plot), the percentage is likely to be 30% to 50%. Once the valuer has worked out the site value, they will then ‘decapitalise’ it (work out the equivalent yearly income), possibly using the same yield as for the ground rent, to calculate the modern ground rent.

The modern ground rent is then valued as a future income – that is, the value (at today’s prices) of the landlord’s right to receive the modern ground rent, but starting at a point in the future (in our example, in 28½ years’ time).

Calculating the second reversion value

As well as capitalising the modern ground rent during the 50-year period, the value of the reversion at the end of this period will be calculated and added on to the above formula to calculate the price of the freehold.

This is known as the second reversion value and is calculated using the standing house value (that is, the value of the property in its existing form and on the basis that it has not been developed to its full potential). This may be lower than the value of the house used to calculate the first reversion.

Applying this to the figures above, the second reversion is calculated as follows.

Standing house value = £114,000

The purchase price for the freehold is the values of the term and the first and second reversions added together.

How leaseholder improvements will affect the valuation

The 1967 act provides no formal guidance as to whether or not the value of any improvements the leaseholder has carried out should be included in the calculation under the original valuation basis (they are specifically excluded from the special valuation basis).

Including the improvements may make a difference in the estimate of the vacant possession value of the house, which is used to assess the site value. The matter centres on assessing a modern ground rent, and the value of the land must be affected by what stands or could stand on it (that is, the value of an average house on the same street, or a building appropriate to the area). When assessing the site value, it is important to understand that it is what could be put onto the site that is relevant, not what stands on it now (that is, the house a developer would build on the site today, not what was built at the start of the lease).

For example, if all the neighbouring houses have an extension or conservatory but the house that is being valued does not, it would be reasonable to assume that if a house was built on the site today, it would probably have the same extension or conservatory. The valuer has to take the actual or non-existent improvements into account when valuing the house to work out the site value.

So, any improvements that have been carried out to the house should be taken into account in relation to what is reasonable for the area. For example, the improvements may be to install a bathroom and toilet inside the house if there was only an outside toilet before. These improvements would bring the house in keeping with the average house in the street, assuming that they have also been brought up to the same standard. In this case it would be quite reasonable to include the value of the improvements in the valuation. (Bear in mind the requirement for a modern ground rent.)

The only situation in which leaseholder’s improvements should not be included is if they make the property substantially better than the average property in the area.

The special valuation basis (market value)

This method is rather different and is based on the reality that the landlord will gain possession of a house and not a cleared site. It also recognises the leaseholder’s special interest in the purchase and this is applied as ‘marriage value’ to be added to the open-market value of the landlord’s interest when the long lease runs out.

Marriage value is a concept used by valuers which describes the increase in value which is produced when two interests in the same property, which used to be owned by different people, are now owned by one person. For example, a house with, say, a 60-year lease may have an open-market value of £100,000, but the same house, in the same condition, might be worth £115,000 if it were freehold. So, when the leaseholder buys the landlord’s interest in the house (the freehold), the value of the house would immediately increase from £100,000 to £115,000. Assuming the value of the landlord’s interest in the freehold is £3,000, the tenant will spend £3,000, but will make a ‘profit’ of £12,000 from the increase in the value of the house. This ‘profit’ is known as the marriage value and, in this case, the cost of buying the freehold would be £3,000 plus half of £12,000 (£6,000).

When calculating the marriage value, the leaseholder’s and the freeholder’s valuers will rely on local knowledge and experience to assess the increase in the value of the house arising from buying the freehold.

The 1967 act states that the marriage value should be shared equally between the leaseholder and the freeholder. No marriage value is paid in cases where the the lease has more than 80 years left to run.

The special valuation procedure can be illustrated by an example using the following assumptions.

• A house has 65 years left on the lease, the ground rent is £50 a year, and the vacant possession value is estimated at £120,000.

Calculating the term

As in the previous example, the future ground rent income is capitalised to produce a value, based on what an investor would be prepared to pay for it.

The ground rent is £50 per year.

Years purchase for 65 years at 7% (from valuation tables) is 14.11.

So, the term is £50 x 14.11 = £705.

The yield rate used is 7%.

Tribunals are less reluctant to consider higher yields in special valuation basis calculations. So it is worth explaining a little more about the effect of varying the yield rate.

The valuer will estimate the assumed yield percentage from a close examination of other transactions, particularly local freehold auction prices, and will calculate the yield from evidence of what freehold investments have achieved in the open market. In effect, because the valuer can use the details of auctioned properties to find out how long was left on the lease and how much the ground rents were for those properties, and will know the prices actually paid, they will be able to do the above calculation in reverse to produce an indicator of the yield percentage being achieved. When analysing these transactions, it is important for the valuer to know the individual circumstances of the sale, as the information they get from the auction results may not always provide completely accurate evidence on which to base other calculations. This can lead to disagreement on estimates of yield percentage by opposing valuers working from the same local market information. The yield is an important element in calculating the valuation, and one that is likely to lead to a difference between the leaseholder’s and freeholder’s valuations.

However, present ground rents are generally low and so their capitalised values are not greatly affected in real terms by the yield rate multiplier. Depending on the length of the lease, it is the reversion value which will vary the most depending on yield rates.

Calculating the reversion value

Unlike the original valuation basis, with this method there is no assumption that the lease will be extended by 50 years. So, at the end of the lease, the landlord will receive the house with vacant possession and will be able to realise its full value. This means it is necessary to estimate the house’s freehold vacant possession value at the end of the existing lease.

The value of a lease reduces as the end date gets closer. So it is reasonable to assume that, if you buy the freehold, the house will be worth more than it is on its present lease. How much more will depend heavily on how long is left on the lease at the time you buy the freehold, and the general saleability of the house. There are no hard and fast rules for assessing the new value. The valuer will have to work out the present leasehold value of the house and the potential freehold value, based on research into sales of similar properties in the area.

For the purpose of the example, we assume that buying the freehold will produce an increase in value of 10%.

A valuer may also account for the leaseholder’s right to stay in the property after the lease has ended. By law, when a long lease ends, the leaseholder can continue to live in the property under an assured tenancy, paying a market rent. In some cases this right can reduce the value of the freehold interest. This is ignored for the purpose of this example.

As with the previous example, the full present value of the house is used to calculate an investment value – what is the promise of £132,000 in 65 years’ time worth today? The multiplier, taken from tables, is applied at the same yield rate used for capitalising the rental income:

The investment value of the freehold

The investment value of the freehold (the landlord’s interest) is calculated by adding together the values of the term and the reversion value.

This is how much interest the house is likely to achieve in an open-market sale.

Calculating the marriage value

As described earlier, marriage value is the increase in the value of the property following enfranchisement or a lease extension. This reflects the added market value of a longer lease or the freehold. Because this possible ‘profit’ only arises because the landlord has to sell the freehold or extend the lease, the law says that the profit has to be shared equally between the landlord and the leaseholder.

Taking the figures from the previous example above:

The improved value of the property is £132,000.

The leaseholder’s present interest is £120,000.

The landlord’s present interest is £2,329.

The marriage value is the improved value of the property minus the leaseholder’s interest and the landlord’s interest (£132,000 – £120,000 – £2,329 = £9,671).

Because the marriage value has to be shared equally between the landlord and the enfranchising leaseholder, the leaseholder would have to pay half this figure (£4,835) to the landlord, as well as the value of the landlord’s interest.

This example shows that marriage value can be considerably more than the value of the landlord’s interest. It depends on the difference between the value of the house with its present lease and the value of the house after the leaseholder buys the freehold and. The smaller the difference between these values, the lower the marriage value. It is important that both the leaseholder and the landlord use a valuer with local knowledge to provide comparable evidence of the local housing market and how, if at all, house values will affect the calculation of the leasehold and freehold interest of the house in question.

As the length of the current lease increases, the difference between its present value and the freehold value reduces until eventually the marriage value disappears.

Leaseholder’s improvements

In calculations under the special valuation basis, any increased value in the property arising from improvements made by the leaseholder should be ignored. Under this valuation method, the leaseholder should not pay any extra premium as a result of value added by improvements which they (or a previous leaseholder) have already paid for.

Completing the valuation

The landlord’s interest is £2,329.

The landlord’s share of the marriage value is half of £9,671 (£4,835).

The purchase price for the freehold is the value of the landlord’s interest plus half of the marriage value (£2,329 + £4,835 = £7,164).

It will be obvious from the example if there are likely to be differences between the landlord and the leaseholder, notably the possible increase in the value of the house after enfranchisement and the share of the marriage value.

The role of the valuation surveyor

Because the law relating to leases is complicated, it is important to have competent professional advice. A valuer can help by:

1. telling you whether you have the right to buy the freehold under the Leasehold Reform Act 1967 and, if so, which valuation method would be used;
2. carrying out the valuation;
3. advising you on the possible purchase price, based on experience and preparing of ‘best and worst case’ valuations;
4. negotiating with the landlord on your behalf; and
5. providing expert evidence at the First-tier Tribunal (Property Chamber).

You would be wise to consult a valuer who is a qualified surveyor – a fellow or associate of the Royal Institution of Chartered Surveyors.

Not all surveyors specialise in this kind of work, and you should make careful enquiries relating to the practice’s experience of the leasehold law before asking them to act for you. You can contact the Royal Institution of Chartered Surveyors for advice on local practices.

Appendix

1. Qualification requirements
   To qualify for the right to enfranchise, you must:
   • have a long lease; or
   • have the lease of the whole house; and
   • have owned the lease for two years.

   Please note: If you have the lease of the whole house, but the house has been divided into flats let on long leases, you are the head leaseholder and do not qualify unless you live in a flat in the house and have done for two years (or shorter periods in the last 10 years, which add up to two years in total).

2. Long leasesA long lease is:
   • a lease which is for a term of 21 years (see note below) from the date it is granted (the lease runs from the date it is granted, not from the start date of the term);
   • a shorter lease which contains a clause giving the leaseholder the right to continuously renew it;
   • a shared ownership lease where the leasehold tenant’s share is 100%. However, this type of lease does not qualify for enfranchisement under the 1967 act if it includes a clause which allows the freehold to be transferred once a leaseholder owns the remaining share in the property. Other exemptions apply if the house was provided for elderly people or within an area referred to as a ‘protected’ area. (Please visit www.legislation.gov.uk/uksi/2009/2098/contents/made for details of the protected areas.)

   Note: How long is left on the lease is not relevant. Whether a lease qualifies as a long lease depends on the original term of the lease when it was first granted.

How to work out which valuation method should be used

Most houses that qualify under the legislation will be valued according to the special valuation basis, including the marriage value.

For the house to be eligible for the original valuation basis (site value) it will need to meet the following conditions, based on rent and values, plus the further value limit.

1. The original low-rent test
   • Leases granted before 1 April 1990 – the yearly ground rent, which you must pay on the date you serve the tenant’s notice and for the previous two-year qualifying period, must be less than two-thirds of the rateable value of the house on:- 23 March 1965; or- the first day the house appeared in the valuation list; or- the first day of your lease; whichever is later. But, if the lease was granted between 1 September 1939 and 31 March 1963, the rent must also be less than two-thirds of the letting value (that is, the rent the landlord could have received if they had let the house under the terms of the lease, but without taking the premium). It is up to your landlord to show if the house meets this condition.
   • Leases granted on or after 1 April 1990 – the yearly ground rent on the day you serve your notice on the landlord must be equal to or less than £1,000 in Greater London or £250 elsewhere.
   • Leases granted on or after 7 September 2009 – in England only – the low-rent test is no longer used so the lease will be treated as if it is at a low rent for the purposes of working out which valuation method to use. (Your local authority or water board may be able to provide the rateable value details, but only a valuation surveyor can advise you on letting values.)
2. Value limitsThese depend on when your lease was granted.
   • Leases granted on or before 18 February 1966 – if your house first appeared on the rating list before 1 April 1973, its rateable value on 23 March 1965 or on the first date it appeared on the rating list (if this is later) must not have been more than £400 in Greater London or £200 elsewhere. Or, if the house first appeared on the rating list on or after 1 April 1973, its rateable value on the first day it appeared on the list must not have been more than £1,500 in Greater London or £750 elsewhere.
   • Leases granted after 18 February 1966 but before 1 April 1990 – if your house first appeared on the rating list before 1 April 1973, its rateable value on 23 March 1965 or on the first day it appeared on the rating list (if this is later) must not have been more than £400 in Greater London or £200 elsewhere. Or, if your house first appeared in the rating list on or after 1 April 1973, its rateable value on the first day it appeared on this list must not have been more than £1,000 in Greater London or £500 elsewhere.
   • Leases granted on or after 1 April 1990 – you must first work out the value of R using the following formula R = P x I / 1-(1+I)^-T P is the purchase price paid when the lease was granted. (If you didn’t pay a purchase price, P is 0.) I is 0.06.
   • T is the total number of years the lease is for (the term). R must not be more than £25,000.

Further value limits

If the house meets all of the above conditions, it will qualify to be valued under section 9 (1) of the 1967 act, but must meet the following further limits to be valued by the original valuation basis.

• If your house had a rateable value on 31 March 1990, the rateable value must have been £1,000 or less in Greater London or £500 elsewhere.
• If your house did not have a rateable value on 31 March 1990, the value must be no more than £16,333 for R, using the formula above.