Proposed Changes to Leasehold Law
A Summary of the Recently Proposed Changes to Leasehold Law
On Thursday 9 January 2020, the Law Commission released a report proposing some ways in which the law surrounding leasehold enfranchisement may be reformed. Parliament can now begin to debate which of these proposals (if any) to enact into legislation. Please note that a change in the law is unlikely to happen in the foreseeable future. Do not delay in taking any action if your lease has 90 years or less remaining.
What is Leasehold Enfranchisement? Leasehold Enfranchisement is the process of extending a residential lease or buying the freehold of the whole block of flats.
What was the Purpose of the Report? The report was commissioned to simplify the way Leasehold Enfranchisement costs (‘premiums’) are calculated, and look into ways that the premium can be reduced and simplified for leaseholders.
The Report would then be presented to the Government to assist any potential future legislative changes.
In order to understand the Law Commission’s report, we must first give you a ‘crash course’ in the way this premium is calculated. The premium is made up of three different figures:-
(1) “The Ground Rent”:
This is the monetary value attributed to the freeholder’s right to receive ground rent for the duration of the lease. In the case of a freehold purchase, the freeholder will lose all rights to charge ground rent. In the case of a lease extension, the ground rent may be reduced to a “peppercorn” (£0) under the Leaseholder Reform, Housing and Urban Development Act 1993. The freeholder will need to be compensated for this loss.
(2) “The Reversion”:
This is the monetary value attributed to the freeholder’s right to exclusive ownership of the property upon expiration of the lease. In the case of an extension, the freeholder will have to wait an additional number of years (usually 90) for the property to revert to them. In the case of a purchase, the property will not revert to them at all. The freeholder will receive compensation for this loss.
(3) “Marriage Value”:
Theoretically, the leaseholder makes a profit (excluding fees) when buying the freehold or extending a lease. This profit is called the marriage value.
The law states that when a lease falls below 80 years, the freeholder is entitled to 50% of this marriage value (the profit). This can add thousands to the premium overnight.
In a freehold purchase, marriage value is only payable on the premium attributed to the participants. The premium attributable to the non-participants has hope value payable instead.
Essentially, Hope Value is the hope of the new freeholder realising the Marriage Value. As it is only a hope, a lower (not fixed) percentage of the profit than 50% is given to the freeholder, say 10%-25%, making these properties cheaper.
Now that we have discussed how the premium is calculated, we will cover the proposals made by the Law Commission. The Law Commission’s report does not consider the compensation attributable to the ground rent or the reversion at length and instead examines the marriage value and the hope value.
Proposal 1: Neither Marriage Value or Hope Value is Payable
By eliminating the marriage value and hope value, the premium would be made up of only the ground rent and the reversion. The Law Commission said that proposal 1 “reflects what the landlord would receive if the lease ran its course and the leaseholder never chose to extend the lease or acquire the freehold: the landlord would receive the ground rent and would get the property back at the expiry of the lease”.
Proposal 2: Hope Value, but not Marriage Value is Payable
By eliminating the marriage value, the premium would be made up of the ground rent, the reversion and hope value. The Law Commission said that proposal 2 “reflects what the landlord would receive if his or her interest were sold to a third-party. An investor purchasing the freehold would not pay marriage value (because the leasehold and freehold interests would remain in separate ownership, so marriage value would not be realised). But an investor might pay hope value, to reflect the fact that he or she might in the future be able to realise the marriage value by selling the interest to the leaseholder”.
Proposal 3: Marriage Value is Payable
Proposal 3 reflects the current law but can be used in connection with the sub-options below to lower the premium. The Law Commission said that Proposal 3 “reflects what the landlord would receive for his or her interest if sold to the leaseholder. By acquiring the landlord’s interest, the leaseholder realises the marriage value, and so would pay the landlord for it”.
The Law Commission’s Sub-Options:
In addition to the above three proposals, the Law Commission has also discussed seven “sub-options” as outlined below.
- The premium is subject to certain rates which are negotiated by each party’s valuers. This causes the premium to vary wildly from transaction to transaction. The Law Commission has proposed that the rates now be prescribed by law to increase certainty for leaseholders. (1)
- The Law Commission has also suggested that there be a cap on the amount of ground rent taken into account when calculating the ground rent compensation. They stated that “ground rents are generally considered to be onerous when they exceed 0.1% of the freehold value of the property”3 and therefore propose that any ground rent exceeding 0.1% of the property value should be ignored during valuation. (2)
- Where a group of leaseholders who live in a block of flats comes together to purchase the freehold, they will need to pay a ‘development value’ to reflect the possibility of them building upwards and adding value to the building. The current law dictates that the development value remains payable irrespective of whether the leaseholders have any intention to develop. The Law Commission has stated that, should the leaseholders accept a restriction on future development, they will not have to pay the development value. If they decide to develop in the future, they may negotiate with the previous freeholder to be released from their restriction, at which point a re-negotiated development value would become payable. (3)
- The Law Commission recognises that it is important to enable people to exercise further rights in relation to their homes and suggests allowing owner-occupiers to pay less upon a freehold purchase/lease extension than commercial investors. However, the Law Commission confesses that there are “significant drawbacks to a regime that differentiates between different categories of leaseholders”.
- The Law Commission considered the possibility of removing the 80-year-cut-off and seeing that leaseholders pay a marriage value irrespective of how many years are left on their lease. The Law Commission suggested that although this would simplify the law surrounding leases, it should only be done in conjunction with a proposal which would reduce the premium overall.
- At present any value added to the property by the leaseholder through home improvements can be discounted from the freehold value of the property, therefore reducing the reversion and the marriage value. However, this can lead to disputes over what home improvements have been made and what value has been added. The Law Commission has concluded that the discount could be “simplified, limited or even removed to reduce disputes”(4). However, as above, this should only be done in conjunction with a proposal which would reduce the premium overall.
- Once a lease expires, the leaseholder often has a right to “hold over”. This means the leaseholder can continue paying rent and remain in the property. In a similar way to sub-option 6, this can reduce the value of the freehold and therefore reduce the premium upon purchase/extension of the lease. The Law Commission state that, should the right to hold over be changed, it should only be done if the result is a net decrease the premium.
The Law Commission concludes their report by arguing that we should work towards an online calculator for that valuation of the premium upon lease extension/purchase of the freehold in order to simplify it for the general public and give them greater certainty before embarking on the leasehold enfranchisement process.
- The Law Commission (2020) Leaseholder Home Ownership: Buying your freehold or extending your lease. Report on Options to reduce price payable Summary. URL: https://www.lawcom.gov.uk/project/leaseholder-enfranchisement/ [accessed: 13.01.2020] P.17
- The Law Commission (2020) Leaseholder Home Ownership: Buying your freehold or extending your lease. Report on Options to reduce price payable Summary. URL: https://www.lawcom.gov.uk/project/leaseholder-enfranchisement/ [accessed: 13.01.2020] P.18
- The Law Commission (2020) Leaseholder Home Ownership: Buying your freehold or extending your lease. Report on Options to reduce price payable Summary. URL: https://www.lawcom.gov.uk/project/leaseholder-enfranchisement/ [accessed: 13.01.2020] P.19
- The Law Commission (2020) Leaseholder Home Ownership: Buying your freehold or extending your lease. Report on Options to reduce price payable Summary. URL: https://www.lawcom.gov.uk/project/leaseholder-enfranchisement/ [accessed: 13.01.2020] P.21