14 Oct Leasehold & Freehold Reform Act 2024
The Effect on Valuations of Freehold Assets Subject to Long Residential Leases
Qualifying leaseholders of residential properties have a statutory right to acquire the freehold or a 90-year lease extension from the freeholder (“enfranchisement”). The price to be paid by the leaseholder is currently determined by a statutory framework under the Leasehold Reform Housing and Urban Development Act 1993 as amended (“the 1993 Act”) and decided caselaw. However, the Leasehold and Freehold Reform Act 2024 (“the 2024 Act”) gained royal assent in May. The section of the Act relevant to enfranchisement has not yet come in to effect, pending secondary legislation. Although it is expected that the new Labour government will bring the enfranchisement provisions into force as soon as it has dealt with its immediate priorities, some uncertainty remains due to multiple Judicial Review challenges that have been launched by landlords. If the provisions of the 2024 Act are triggered it will significantly alter the way in which the price paid by a leaseholder to enfranchise is calculated. It also contains a mechanism whereby a leaseholder can “buy out” their ground rent and convert it to a peppercorn without having to extend the lease.
The 1993 Act Regime
Currently the price which a leaseholder would be required to pay to enfranchise is made up of three components:
- the value of receiving the ground rent for the remainder of the lease;
- the vacant possession value of the property to the freeholder if the lease was surrendered (“VPV”) deferred to end of the existing term (less VPV deferred to the end of the extended term in the case of lease extensions – usually negligible); and
- (where the unexpired term is less than 80 years) the difference between the price the leaseholder could sell their property for (on the assumption that the 1993 Act does not apply to the lease) and the VPV less (a) and (b) above, known as “the marriage value”.
Prior to the 2024 Act being triggered the price a freeholder receives on enfranchisement is (a) plus (b) plus half of (c).
The 2024 Act Regime
The effect of the new Act is to abolish (c) and put in place a revised valuation framework which broadly adopts the same principles for the calculation of (a) and (b) but using an “applicable capitalisation rate” for (a) and an “applicable deferment rate” for (b), These rates will be determined by the Secretary of State and have not yet been published. The sum that a freeholder receives is quite sensitive to these rates, resulting in a significant degree of valuation uncertainty for the time being.
The Act also introduces the concept of a notional annual rent of 0.1% of the market value (VPV/1000), which is to replace the actual rent or any rent under a subsequent review if it exceeds the notional rent for the purpose of calculating the price payable. This may significantly reduce the sum received at (a).
The price freeholder would receive if a leaseholder decides to buy out a ground rent is the same as (a) subject to the notional annual rent cap.
Effect on the Value of Portfolios
Historically, most large portfolios of freehold investments to which enfranchisement applies have reflected the probability that some marriage value will be received each year, usually by allowing some income within a cashflow model. Although the 2024 Act has yet to come into force, it is inconceivable that a purchaser of such assets would reflect the possibility of receiving any future marriage value income in the price they paid now. It is not therefore appropriate for such income to be reflected in any valuation. In recent years the amount of marriage value reflected in portfolio valuations has been reduced significantly in the expectation that it would be abolished, and we expect the effect of the 2024 Act on portfolio valuations, insofar as it relates to marriage value, to be minimal (if the portfolio has been the subject of regular revaluations by a competent firm).
However, the application of a notional annual rent cap to the calculation of the enfranchisement price was not widely appreciated prior to the introduction of the legislation and potentially affects all the assets in a portfolio, not just those with shorter leases. It also introduces an additional level of complexity into valuations as the valuer must assess the VPV of each asset to adjust for notional rent cap where it will apply. Previously, where an asset was subject to a long lease (80+ years) the VPV was irrelevant to the valuation as the projected ground rent income was simply valued in perpetuity.
Conclusion
Whilst the effect of the abolition of marriage value and the notional cap on ground rents can be factored into valuation calculations now, because the capitalisation and deferment rates have not been published there remains significant uncertainty. This is also a market sector where there are few transactions from which to ascertain how the market is pricing this risk. In our view, the circumstances constitute material valuation uncertainty and we anticipate MVU qualifications will be included in valuation reports of ground rent assets until the capitalisation and deferment rates have been published.
Property values in the major cities and the southern regions of England are usually sufficiently high that most ground rents will be below the cap. The sector which might be most affected is retirement properties where ground rents tend to be a relatively high proportion of the vacant possession value.
Simon Crust FRICS
RICS Registered Valuer
October 2024
This discussion paper is intended to raise awareness of potential valuation uncertainty arising pending the introduction of the Leasehold and Freehold Reform Act 2024. It summarises the legal and valuation issues. It may not be relied upon as a professional or legal opinion. If you require advice on a specific matter please contact the writer.
M: +44 (0) 7799 067723
E: simonc@promission.co.uk