VALUATIONS FOR LEASEHOLD ENFRANCHISEMENT A NEW APPROACH TO RELATIVITY.

This paper has been presented in an effort to arrive at a new approach to calculating relativity in enfranchisement valuations.

AUTHORS

Kieron McKeown MRICS is a Chartered Surveyor and principal of McKeown & Co LLP, a firm that deals largely in leasehold enfranchisement work acting for landlords and lessees. In recent years, he has been involved in more than 1200 lease extension cases. He is a member of ALEP and has appeared before London, Midland and Eastern Tribunals.

Paul Church FCA is a Chartered Accountant of more than 46 years of experience, having worked both in practice and in commerce. He has always had a particular interest in property valuation matters. He owns a portfolio of freehold ground rents and also buy to let investments, including flats which he bought with short leases. As a Chartered Accountant, he was trained in statistical sampling, whilst as a buy to let investor he has first hand knowledge of what motivates investment decisions.

PREFACE

The purpose of this paper is to develop a relativity graph based upon the 2-Step approach suggested in “UKUT0223LC 2016 The Trustees of the Sloane Stanley Estate and Adrian Howard Mundy.” (Referred hereafter as “Sloane Stanley”).

As we make clear later herein there are a number of limitations to the graph produced, but if it is found to be useful to Tribunals and Valuers, we believe that it can be further refined to deal with cases which presently fall out of its remit.

INTRODUCTION

The authors have both had considerable experience in Leasehold Enfranchisement and have been increasingly concerned as to the (almost) automatic use of graphs by many Tribunals and those involved in Leasehold Enfranchisement.

Instead of looking to evidence first, and falling back on graphs in the last instance, there appears to be an increasing use of graphs at the outset. This may well be due to costs pressure; many Lessees want valuation fees kept down to the lowest level which means many professionals do not have time within the fee to look for short lease comparables which invariably involves trawling through Land Registry data.

The problems found by the authors are;

1. Many of the graphs differ widely, especially between 50 and 70 years.
2. Averaging the graphs by a mean average, which is often done by Tribunals is statistically unreliable. To average one graph with 200 cases, with another graph that may comprise 500 cases, means that a weighted average needs to be used, we have never seen any attempt to do so.
3. There is too little information about how the graphs are made up. How many cases, the percentage of statutory and informal cases, and basis of calculations. Are all the cases in a “No Act World”? We know that some are not.
4. Even the production of graphs is unclear, are they based upon mean average, weighted average, are they based on all cases or have highest and lowest figures been eliminated
5. Finally, there is little information as to when the graphs were last updated. The LEASE graph which is commonly referred to by Tribunals was last updated in 2007. In fact, if one refers back to the Beckett and Kay 2009 presentation of RICS data and compare it with the 2014 version the only graph that appears to have altered is the Beckett and Kay mortgage dependant graph. It would appear that many of the other graphs have not been updated.

CONCERNS

The authors have themselves found, increasingly, that where there is good evidence as to long and short lease values, the relativities are invariably greater than that shown in the common graphs being used in the profession.

Our concern increased when we saw BIR/00CN/OLR/2015/0060 and 0061. Here by looking at a number of actual cases in the Birmingham area, the Expert concerned was able to demonstrate that they were averaging 8% below the LEASE graph for the term concerned. Although the Tribunal in that case decided to use a relativity 8% below the LEASE graph, it does not appear that the same adjustment has been used in other Midland cases.

The authors have also found increasingly that Lessees or potential purchasers are being given figures for the likely costs of lease extensions that often bear no resemblance to the final figures.

SLOANE STANLEY

Many of our concerns appear to have been voiced in this case. We note in particular the following comments;

"We have had the benefit of hearing detailed evidence about the construction and use of those graphs. From such evidence, we are satisfied that at the valuation date a prospective purchaser would not have taken an average relativity from those graphs. It is most likely that they would have referred to the GE graph first and foremost."

"It was agreed by valuation experts that the price payable for an existing lease was influenced by the amount arrived at by deducting the estimated cost of the lease extension from the long lease value."

"If that were to happen valuers and tribunals might have more confidence in a method of valuation of an existing lease without rights under the 1993 Act which proceeds by 2 stages. Stage 1 would be to adjust the FHVP for the property to the value of the existing lease with rights under the 1993 Act by way of using the graph which has emerged. Step 2 would be to make a deduction from the value to reflect the absence of rights under the 1993 Act on a statutory hypothesis."

REQUIREMENT

We believe that there needs to be a new approach to relativity which is based upon the real world and is likely to more closely resemble actual existing and long lease prices; relativity figures which professionals can rely on with confidence.

In our view this can be accomplished by the 2-step approach favoured in Sloane Stanley AND then going further by amalgamating the 2 steps to arrive at a relativity graph which has the absence of rights built in.

IS THERE A SIMPLE ANSWER

We believe that following Arrowdell, everyone in the profession became so reliant with graphs that the obvious answer may have been missed.

The answer we believe is to;

1. Take the difference between the extended lease and the existing lease (with rights) as being the premium payable together with likely costs and a small contingency. (This does mean having a figure for either the extended or the existing lease, but only one of them and working out the premium which will include the deduction in II. below).
2. Make a deduction from the value of the existing lease to reflect the absence of 1993 act rights.
3. From the resultant calculations, create a graph of % relativity of existing lease with no rights to the extended lease value.

To the best of our knowledge it was first set out in LRA/108/2008. 20C Mountview Road, N4 4HX, here the Upper Tribunal indicated that in its opinion the value of the long lease would be;

There is a certain obviousness about this, no one is going to pay £180,000 for a short lease, if the total costs of a lease extension are £40,000 and the long lease is only worth £200,000!!

They would surely bid £160,000.

Indeed, any buyer of a short lease who is reasonably advised, is going to bid a price that with the likely premium plus costs and factoring in a reasonable contingency, is no greater than the long lease price.

If the above premise is accepted then only one value is ever needed, either the long lease or the short lease with 1993 act rights:

IS A GRAPH POSSIBLE

Yes, if you take a standard model, it is a mathematical equation which can produce a figure for each year of unexpired term.

The model needs to be defined carefully.

MODEL

We propose a Model based upon the following;

A typical 99-year lease 2-bed flat with a fixed ground rent of £75. Market Value with long lease £200,000.

We will use the following:

1. Long Lease value	£200,000
2. Existing Lease value with rights	To be determined see below
3. Existing lease without right	Above less (2.5% + 0.2% for every year less than 78)
4. Improvements	None
5. Rent	£75
6. Deferment	5%
7. Capitalisation	6%
8. Marriage	50%
9. Landlords residual rights	5%
10. Assume unimproved with all covenants in order

NOTES. Existing Lease value with rights will be Long Lease less (premium + costs of £4000 + contingency of £1000)

We have used £1000 for contingency as this was the figure used by UT in LRA/108/2008. 20C Mountview Road, N4 4HX.

We have used £4000 for costs based upon our experience of likely costs, and assuming the Valuer conducts the case at Hearing and no need for barrister/solicitor.

• Lessees surveyor for initial valuation £350/450 + VAT
• Lessee surveyor to negotiate, prepare and conduct case 8 hours @ £120 = £960+ VAT
• Lessee solicitor to serve Notice, agree new lease etc £1000 + VAT
• Landlords surveyor £720 + VAT
• Landlords solicitor £800 + VAT

The above will come to £3830 + VAT = £4596.

We have rounded down to £4000 as being the likely amount a Lessee might expect to pay rather than what he is likely to end up paying.

Existing Lease Value without rights has been based upon 3 key decisions;

• UT: LRA/108/208 20C Mountview Rd which found 2.5% at 78 years.

• FTT: LON/00BC/OLR/2015/1057. 3A Valebrook. Ilford, IG1 4RT which found 7.5% with 52.6 years.

• UT: LRA/128/2007 & LRA/17/2008 consolidated Cadogan which found that deduction increases as lease gets shorter and 10% at 44 years.

Taking a line of all 3 of the above, indicates that the deduction increases by approximately 0.2%pa for every year below 78, which interestingly correlates closely with the deduction in the Savills graphs.

So:	78 years	2.5%
	77 years	2.7%
	76 years	2.9%
	75 years	3.1% etc.

Condition: We do not need to make any adjustment for condition, as that will be taken up in the price

Location: We do not need to take location into account as it too is taken up in price.

Improvement: We do not need to consider as we are only concerned with relativity.

RELATIVITY GRAPH

Based upon the above model we have prepared a graph of relativity which we believe mirrors more closely what an informed buyer will pay for a short lease.

We believe that it is likely to be more accurate than other graphs, being based upon practical reality and even eliminates the “above and below the line” figures that affect other presently available graphs.

RISK FACTORS

A relativity graph along the above lines, will we believe be much closer to the real world than any of the present graphs. However, it comes with a HEALTH WARNING, it is only a reasonable indication of a typical lease.

We have in our calculations used long lease value and not FHVP. This is because many cases do not uplift to FHVP (although we believe that they should do so.). It does add conservatism to our figures.

Many leases are untypical and there will still be areas that it cannot cover, the impact of which will be to lower the relativity % and increase the premium. Principally;

• it ignores rising rents.
• It ignores unusual and onerous rent reviews.
• it ignores cases where the deferment rate is more than 5%.

ASSUMPTION WARNING

One of our assumptions is that a buyer will only factor in a £1000 contingency. This is the only figure that we have ever found used by the UT and therefore we have decided to use it as well.

However, in practice we think a buyer will factor in a larger figure.

As a result, we believe that there is a degree of inbuilt conservatism in our figures.

SIZE VARIATIONS

This graph will be most accurate in ranges up to £300,000, which will cover about 90% of most cases outside of PCL., After that a degree of inaccuracy will arise as the proportion for costs and contingency shrink in relation to the overall figure that an investor contemplates.

This can be seen most easily as follows;

Extended lease £300,000 Premium £25,000 + costs £4000 + contingency £1000 = £30,000		10% of extended lease value.
Extended lease £900,000 Premium £75,000 + costs £4000 + contingency £1000 = £80,000		8.88% of extended lease value.

This can be addressed in a variety of ways;

1. It could be argued that for higher priced properties the slack will be taken up by greater costs especially in London.

2. A simple % addition to our figures for higher priced properties.

3. Or if this finds favour with Valuers and Tribunals, we can create additional graphs at higher price ranges.

OTHER HEALTH WARNINGS

We have not made any S10 deduction for these purposes, evidence suggests that for leases above 50 years this is not something that a buyer even considers.

We have equally not considered S61 rights, again we believe that these do not come into account until the lease is less than 50 years unexpired.

We believe that this method of computing relativity is only reliable down to 50 years unexpired, at that stage many other imponderables come into account.

SUMMARY

Calculating in accordance with the above for each year from 78 years to 50 years the results can be seen from the accompanying calculations and graph.

They may be summarised by the following chart.

It is interesting to compare with the Gerald Eve graph, initially at 78 years they are 3.8% apart but as the term decreases the difference closes so that at 60 years they are 2.135% apart and by 50 years they are only 1.065% apart.

The difference can be explained as it appears that in the main GE were dealing with more valuable properties where the allowance for costs and contingency would be a lower percentage of extended lease value. (See our earlier paragraph on Size variations) As the lease gets shorter and the premium increases this will increasingly become a smaller percentage leading to a converging of the figures. The recent decision in LRA/111/2015. 12 Needham Road, W11 2RP which used 1% below Gerald Eve was pretty close to our figure for relativity.

RELATIVITY GRAPH

CALCULATIONS

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