The Property Litigation Association has been instrumental in providing a comprehensive response to the Law Commission’s consultation on making enfranchisement easier, quicker and cheaper. The first set of proposals with options for reducing enfranchisement prices was published in January 2020 (see Leasehold Enfranchisement: The wait is over, EG, 25 January, p48). The Law Commission’s further report on procedure was due this spring but now seems likely to be delayed by the Covid-19 pandemic.
Once the government has both reports, it is expected to produce new legislation which could transform the enfranchisement process. In the meantime, leaseholders are considering whether they should delay their claims and landlords are worrying about the likely impact on their investments. In this article, we consider some of the more common questions vexing the residential property market.
What are the key proposals?
The Law Commission’s report puts forward three schemes for determining the purchase price, with a series of sub-options. Some consider that the Law Commission has not gone far enough, but it has been restricted in its efforts by the European Convention on Human Rights and had no choice but to leave the final decision to government.
Each scheme retains the capitalisation of the ground rent for the remainder of the term and the loss of reversionary value. The variable factor is the marriage value. Marriage value is the uplift in value that results when the leasehold and freehold interests are “married” together. The options are:
1. no marriage value
2. hope value replacing marriage value
3. marriage value payable as before.
Valuations one and two would reduce the premium, while three reflects the current position for leases of less than 80 years. These could be combined with other amendments as follows:
a) prescribing rates (capitalisation rates, deferment rates and relativity);
b) capping ground rent (ie possibly ignoring onerous ground rents of, say, more than 0.1% of FHVP value);
c) electing whether to pay development value or opting for a restriction on title which could be removed later;
d) differential pricing for different leaseholders (owners versus investors)
e) removing the cut-off point for marriage value (currently 80 years);
f) discount for leaseholder’s improvements; and
g) holding over discount (this could be removed, or a standard discount might be set).
The Law Commission also discusses the possibility of creating an online calculator and seeking to retain or simplify valuations under section 9(1) of the Leasehold Reform Act 1967 for low-value houses as they produce the lowest premiums but are complex valuations that are open to dispute.
Which option is most likely?
If you asked a panel of experts in the field, you would probably get a different answer from each one. Our feeling is that dramatic reform is unlikely, and so option three – ie the status quo – is likely to win. That’s not to say that the process will remain entirely as it is now. It is likely that there will be minor (easy to legislate) changes, such as removing the landlord’s recoverable costs and the two-year ownership requirement, and possibly some changes to the treatment of ground rent.
One likely change is capping the ground rent at, say, 0.1% of freehold value. This would lower premiums and specifically target those leaseholders stuck with onerous ground rents but could cause a conflict with pension funds that rely on ground rent income.
If the government focuses on rates, a robust mechanism would be needed for their determination. If valuation inputs were to follow the market, it is likely that deferment rates and leasehold/freehold relativity (existing lease values) would shift in the landlord’s favour, which would increase premiums rather than reduce them.
When will these reforms take effect?
The Law Commission has yet to produce a complete package of proposals, after which there will be a further delay while the government decides which to adopt. Then a new Bill will need to be approved, which takes time.
Minor tweaks to the existing legislation could be done relatively quickly, but if the valuation methodology or qualification requirements are to be replaced, a whole new Act is likely to be required, which could take years.
If I am a leaseholder, should I wait to serve notice?
The aim of the Law Commission review is to make the process cheaper and easier, so you would think the answer is “yes”. However, we don’t yet know which (if any) of the three options will ultimately become law. It also depends on the circumstances and what type of claim you are making.
Lease extension claims
If the lease is nearing 80 years unexpired, the tenant should make a claim as quickly as possible to avoid paying marriage value, which will significantly increase the premium. Should the government choose option one (no marriage value), the length of the term would no longer matter, but it would still be worth going ahead as any reduction in term will increase the premium. If there is a very long term remaining, ground rent is not onerous and there are no other complications, it is advisable to wait because the cost of making a claim is likely to decrease.
Collective claims
Depending on the size of the block, collective enfranchisements can be extremely difficult and time-consuming. If there is a desire to go ahead, we would advise leaseholders to capitalise on that momentum and try to get the claim over the line. Organising the legal side, such as the participation agreement, can take months, and it’s possible that by the time the notice is ready to be served there will be more clarity about the likely timescale.
House claims
Under the the 1967 Act, it depends which valuation method applies. Section 9(1) valuations are the cheapest and, under the current legislation, no marriage value is payable. The Law Commission says it wants to preserve this, and indications are that the valuation will remain the same.
By delaying, the lease term will get shorter and the premium more expensive (assuming there is no dramatic downturn in the market). It would therefore make sense to go ahead. In other cases, where marriage value is payable below 80 years, the advice relating to flat lease extensions applies.
Is now the time for investors to buy short lease interests?
A purchaser of a short lease can work out the value of the lease once extended and how much it will cost to extend. The difference between these two numbers gives a rough idea of how much they should be paying for the existing short lease.
If the cost to extend the short lease suddenly drops as a result of law reform, this will presumably be reflected in the market. Logically, short lease interests will suddenly become a lot more valuable. Investors may find that their interests are worth significantly more without even making a claim.
Of course, this is a gamble. While waiting for the reforms to become law, the short lease is becoming shorter. The landlord’s reversion will be edging closer and the premium is likely to be getting higher each day and might not in fact change that much as a result of the reforms.
My landlord is offering a “voluntary deal” for a lease extension. Should I take advantage of this?
Enfranchisement is, by its nature, a tenant-led process. The landlord has no control over when or if a tenant exercises its rights. At this uncertain time, some landlords may want to unlock the value of their reversion now and offer a voluntary deal. While it does avoid uncertainty and allows a landlord to extract a premium, there are disadvantages, such as a lack of capital gains tax roll-over relief.
Conversely, a landlord offering a voluntary deal could be taking advantage of a tenant unaware of possible legislation changes. Some landlords may also seek to include terms in the new lease that would not ordinarily be permitted, such as including a ground rent subject to review rather than reducing rent to a peppercorn.
Are landlords being treated unfairly?
While there are unscrupulous landlords in the market, many still seek to maintain and manage properties to a high standard. Leasehold property has also been regarded as a good investment due to its long-term, guaranteed ground rent income and potential enfranchisement premiums.
Some investors holding properties for pension or charitable purposes would be hit by the proposed changes, leading to professional landlords potentially exiting the market. Others who have collectively enfranchised their blocks of flats and, in the process, acquired the reversion to any non-participating flats as an investment may be adversely affected by reduced premiums.
How will the reforms affect intermediate landlords?
Any reduction in premiums potentially has a knock-on effect for intermediate leaseholders who manage blocks of flats. They often collect ground rent income and receive a share of the lease extension premiums, in addition to running a service charge. Reducing the amount payable to them could conceivably result in it becoming less desirable to effectively manage buildings.
Should I serve my claim during the coronavirus pandemic?
From a legal perspective, most parties are seeking to agree that notices can be served and accepted by e-mail. Certainly, this is the protocol that has been introduced by the Association of Leasehold Enfranchisement Practitioners.
From a valuation perspective, the exact consequences of serving a notice now are unknown, but inspecting property during the lockdown is either challenging or impossible, so it is difficult to see how evidence of a fall in value could be provided.
Natasha Rees is a partner at Forsters and member of the PLA’s law reform committee, Charlie Coombs is a partner and head of the residential leasehold enfranchisement team at Gerald Eve and Henrietta Hammonds is a partner at Beckett and Kay
