This is usually one of the first questions that I’m asked when I receive an enquiry about lease extensions. I can understand that a lessee would want to know this when considering a lease extension but it’s not an easy question to answer over the telephone or even in an article such as this.
I will just clarify that when we use the term “lease extension” we are talking about a claim for a new lease under Chapter II, Part 1 of The Leasehold Reform, Housing and Urban Development Act 1993.
The new lease will be at a “peppercorn” i.e. no rent and for a term that expires 90 years after the end of the existing lease. The lessee will have to pay a premium to the landlord for the grant of the new lease and this premium has to reflect the diminution (decrease) in value of the landlord’s interest in the property when the new lease is granted. The Act sets out the way in which this diminution should be calculated, but there are so many variable factors it is not possible to give a precise valuation without inspecting the property itself and the terms of the lease.
On a standard residential lease the landlord will usually receive a fairly low ground rent for the duration of the lease. This will often be in the region of £50 to £100 per year and can be fixed for the duration of the lease or rise during the course of the lease. The new lease will effectively have a “zero” ground rent and the landlord has to be compensated for the loss of this income. This loss has to be calculated on the basis of “what is the present value of the right to receive £X per year for the next Y years“. Put simply this means how big a lump sum would you have to invest today to give you an income of say £100 per year for the next 75 years. We have to assume that the lump sum we invest would attract interest and that this would generate the growth to provide our annual income.
This interest rate is called the “capitalisation rate” and will generally be somewhere between 6% and 7%. The lower the interest rate the higher the lump sum will be.
If the existing lease were to run to the end of its term, the property would revert to the landlord. If we say that a flat is worth £250,000 and has an unexpired lease of 75 years we can say that the landlord could expect to receive £250,000 in 75 years time. Again, we have to carry out a calculation to arrive at the “present value of the right to receive £250,000 in 75 years time”. Again we have to assume an interest rate, which is called the “deferment rate”. This time the courts have been quite helpful and previous case (Sportelli) has established that for flats the deferment rate will be 5%.
By applying the above calculation we arrive at a figure that represents the current value of the landlord’s interest in the property.
We now have to consider what the landlord’s interest will be worth when the lease is extended. In our example case the new lease will be 75 + 90 years (165 years). We now have to consider what the present value of the right to receive £250,000 in 165 years will be, using the same deferment rate of 5%.
By deducting the value of the landlord’s interest after the grant of the new lease from the value of the landlord’s interest before the grant of the new lease we arrive at a figure that represents the landlord’s diminution in value.
The final aspect that we have to consider is “Marriage Value”. This is defined as the difference between the combined values landlord’s and tenant’s interests before the grant of the new lease and after the grant of the new lease.
The length of the existing unexpired term of the lease is very important in this regard. If the existing lease has 80 or more years unexpired, The Leasehold Reform, Housing and Urban Development Act 1993 says that the element of Marriage Value is disregarded when calculating the landlord’s diminution in value. However, when the unexpired term of the lease is less than 80 years Marriage Value is shared equally between the landlord and the tenant.
To summarise the premium that a lessee will have to pay for the grant of a new lease is made up of the following elements:-
- A payment to compensate the landlord for the loss of his ground rent
- A payment to compensate the landlord for the diminution in the value of his reversionary interest following the grant of the new lease.
- A 50% share of the “Marriage Value”â€™” if the existing lease has less than 80 years left to run
As I said at the outset, the method of calculation is set out in the Act, but in view of the number of variables, such as lease length, amount of ground rent, market value of the flat etc. that it is not possible to give a simple answer to the question of, “how much will it cost to extend my lease?”
Each case has to be treated on its merits and the simplest answer that I can give is that you should consult a Chartered Surveyor who specialises in Leasehold Reform valuations before deciding to claim a new lease on your flat.