The Government’s consultation on leasehold enfranchisement valuation rates is important because it will help determine what leaseholders pay to extend leases or buy freeholds, and what freeholders receive in return. But I think the debate risks becoming too narrowly focused on which percentage should be chosen.
The Leasehold and Freehold Reform Act (LAFRA) will introduce a Standard Valuation Method and allow prescribed deferment and capitalisation rates.
At the same time, marriage value is intended to disappear and the treatment of ground rent is changing. For property investors, those reforms cannot sensibly be separated.
They affect different parts of the same asset and together they change the economics of existing freehold interests.
THERE IS NO NEUTRAL RATE
The deferment rate is used to value the freeholder’s right to recover the property when the lease expires. The current benchmark is 5% for flats and 4.75% for houses, following the 2007 Sportelli decision. A higher deferment rate reduces the present value of that future interest, while a lower rate increases it.
Government modelling makes the consequences unusually clear. For an illustrative £250,000 flat with 80 years remaining, reducing the deferment rate from 5% to 4% increases the reversion value from £5,044 to £10,846.
Raising it to 6% reduces it to £2,363. These are not total premiums, but they show how much can turn on a single percentage point.
Across the market the difference is larger still: against a 5% baseline for flats, the Government estimates that a 3% deferment rate could mean leaseholders paying around £6.3 billion more to freeholders over 10 years.
At 6%, leaseholders would pay around £1.1 billion less. This shows transfer of value between the two groups involved in the leasehold enfranchisement process rather than on the economy as a whole, but that is precisely the point: prescribing the rate decides where value sits.
CAPITALISATION IS EVEN LESS UNIFORM
The capitalisation rate values the future ground rent income stream. Here the existing evidence is far less standardised. Government analysis of First-tier Tribunal decisions found rates ranging from 4.5% to 9%, with 88% of cases in the sample between 6% and 7%.
That variation is to be expected, because ground rent investments differ by rent level, review pattern, lease structure and risk.
A single prescribed rate may create welcome consistency, but it also removes some of the ability to reflect those differences. The issue becomes more complicated if existing ground rents are separately capped, because the income stream being valued may itself be reduced.
FINDING A FAIR PRICE
I think this question sits at the essence of the consultation but is not asked directly enough. Enfranchisement valuation has historically sought to approximate the value of the interests being acquired using established valuation evidence. The proposed system moves further towards assumptions set by government policy.
Leaseholders have legitimate concerns about complexity, cost and uncertainty and I support the objective of making enfranchisement easier to understand.
But freehold interests have been acquired lawfully, often by a wide range of investors (including public sector bodies, charities and pension funds) rather than a single caricature of the ‘landlord’. Future change should be clear about the basis on which those interests are being compensated.
The investment market is already looking ahead. Expectations about future ground rent income and reversionary value are already affecting portfolio pricing before legislation takes effect.
That makes clarity more important, not less. Investors need to know not only the rate Government chooses, but how it has assessed the combined effect of marriage value, ground rent reform and the new prescribed assumptions.
SIMPLIFICATION SHOULD NOT MEAN LOOKING AT THE PARTS IN ISOLATION
As an ALEP member, I support meaningful leasehold reform and recognise that commonhold will have an important role in the future.
I also think the transition must be handled carefully. A simpler formula is useful only if the overall outcome is fair, workable and capable of commanding confidence across the property market.
So the consultation is a necessary step, but the eventual response needs to go beyond selecting two percentages.
It should explain what the new valuation system is trying to achieve, how value is intended to be shared between existing interests and how the different strands of reform work together. For investors, that is the real question behind the rates.
