On 9 January 2020, the Law Commission, further to their 2016 consultation, published their report on options to reduce premiums payable by flat owners (“tenants”) to their landlords to extend the term of their lease or buy their freehold interest.
The report discusses three potential reform options which centre upon how premiums are calculated with the overarching focus being to reduce the price payable by tenants; the question then being “but what about compensating landlords?”
Enfranchisement and lease extensions
When tenants seek to collectively acquire the freehold interest in their building from their landlord, they pay a premium. This reflects the fact that after the enfranchisement, the landlord’s entitlement to the property and right to receive ground rent is lost. The heightened interest tenants obtain through an enfranchisement claim (i.e. owning the freehold) is valuable and correspondingly, the landlord is compensated.
Where the term of a lease is extended under the Leasehold Reform Housing and Urban Development Act 1993 (‘1993 Act’), the tenant will instruct a surveyor for valuation advice regarding the premium that is likely to be demanded by the landlord for the enhanced value conferred onto the tenant by obtaining a ninety year lease extension.
Premium calculation
Currently, the premium to be paid to the landlord will be determined by a surveyor based on:
- relativity
- the value of the landlord’s interest
- the release of the marriage value (being the difference in the value of the property if the leasehold and freehold interest was owned by the same person or held by the landlord and tenant respectively) when the tenant subsequently comes to own the freehold interest in a property post enfranchisement; and
- potential development value.
As described in the Law Commission’s Report, tenants take the view that lease extensions and enfranchisements are too expensive. The calculation of premiums should be simple and it is unfair a leaseholder should essentially have to pay twice to obtain full security of their home.
On the other hand, landlords take the view that tenants should pay full market value for the asset, having initially paid a reduced price in return for the annual ground rent.
In considering the opposing views, and taking into account human rights of both landlords and tenants, the Law Commission has proposed three schemes, outlined briefly below.
Scheme 1
This assumes the tenant is not and never will be in the market. Therefore the premium produced reflects what the landlord would receive if the leaseholder never chose to extend the lease or buy the freehold and no marriage value would be payable.
Scheme 2
This assumes the tenant is not in the market at the time the premium is calculated, but will be in the future. This reflects what a landlord would receive if their interest was sold to a third party. Similarly, no marriage value would be payable.
Scheme 3
This reflects the way that premiums are calculated under the current law, but is designed to be combined with other reforms to potentially reduce the premium payable.
The Law Commission has not recommended any one of the three schemes. It is evident that implementation of Scheme 1 or 2 will, beneficially for tenants, reduce the premium payable. However, as contested by landlords, when buying a leasehold property, tenants have agreed to pay for a time-limited asset and should compensate the landlord when the landlord is compelled to sell their interest under the 1993 Act.
Currently, it remains to be seen whether any of these proposals will be implemented in the future and the Government have the challenging task of ensuring that, primarily, any wholescale reform of the premium calculation process is fair.
Our Enfranchisement team is able to assist both landlords and tenants in relation to lease extensions and enfranchisement matters.
