Leasehold Reform: Premiums for Lease Extension and Enfranchisement

On 9 January 2020, the Law Commission published its report on the options for reducing the costs payable by leaseholders extending their leases or purchasing the freeholds of their properties. The report is focuses on the premium payable by leaseholders to freeholders when they extend a lease or acquire a freehold, but also touches on other costs payable by leaseholders, such as professional fees.

The biggest changes proposed are to the method of calculating the premium. Three ‘schemes’ have been proposed, with differences in the treatment of ‘marriage value’ and ‘hope value’.

A freehold which is not subject to a lease is usually worth more than the combined value of a freehold which is subject to a lease, and the value of that lease itself. This is because when the freehold and the leasehold are in the same ownership, the owner has greater freedom over their use of the property than either a leaseholder or a freeholder subject to a lease. The difference between the two values is known as marriage value. A freeholder selling their freehold to a leaseholder will be able to charge a higher sum to reflect the additional value realised by the leaseholder. A freeholder selling to a third party will not be able to charge as high a sum, but may charge some uplift, to reflect the fact that the third party might some day be able to sell to the leaseholder and charge marriage value at that stage. This is known as ‘hope value’.

1. Under the first scheme, both marriage value and hope value are disregarded. The valuation is worked out by adding together the ground rent that would be paid during the remainder of the term (less a reduction to account for the landlord getting the money up front) and the value of the interest being purchased (either the extended lease term, or the freehold).
2. Under the second scheme, the calculation includes the ground rent, plus the value of the interest being purchased, plus ‘hope value’. Marriage value is excluded.
3. Under the third scheme, the calculation includes the ground rent, the value of the interest being purchase and marriage value.

Schemes 1 & 2 will reduce the premium payable. Scheme 3 is the existing method of calculating the premium.

The report also raises the possibility of other changes to the leasehold system. The possible changes likely to have the biggest impact are:

1. Prescribing the rates used to calculate the value of the interest purchased, the value of the ground rents, marriage value and hope value. This would significantly simplify the valuation process and reduce professional costs and risk of litigation, but risks a ‘one-size-fits-all’ approach which does not accurately reflect the value of freeholders’ interests.
2. Capping ground rents. Onerous ground rents have been in the news frequently and the report proposes that when a premium is calculated, the value of the ground rents could be capped to 0.1% of the freehold’s value.
3. Enabling leaseholders to avoid paying ‘development value’ for any potential development of the freehold they are acquiring. While this would reduce the premium payable, it makes further development of those properties more difficult, potentially removing a source of future housing.

The report does not recommend which of the above options the Government should progress, but it is clear that any of the major changes are likely to reduce the premiums payable, reducing the value of freeholders’ investments. Further reports from the Law Commission with more possible reforms to the leasehold system are due in the next few months.