In the first of its responses to an ambitious series of property law consultations, the Law Commission has issued its report on how enfranchisement claims should be valued to calculate the premium payable by tenants when they enfranchise.
Enfranchisement is the process by which residential tenants of a building collectively can acquire the freehold title to their properties. There is a parallel process by which tenants of houses can acquire the freehold title to their houses. The process is complex and, as the number of cases illustrate, valuation is often a source of dispute. When the government asked the Law Commission to review enfranchisement, they specifically asked it to consider how the valuation process could be simplified and the premiums payable by tenants reduced.
The Law Commission has produced a long report looking at the various options available to achieve the government’s aims. However, as the Law Commission stresses, the method of valuation to be adopted and any resulting reduction in premiums payable is a social and political decision to be made by the government.
Many tenants argued that the premium should be calculated as a simple multiplier of the rent that they pay under their leases or a fixed percentage of the open market value of the property. However, the Law Commission has concluded that a simple valuation process such as this is unlikely to be compatible with human rights legislation and would be open to challenge by both landlords and tenants who were unfairly prejudiced by blanket approaches such as these.
The Law Commission has put forward three principal valuation bases for consideration. It will be for the Government to decide which of them it prefers.
- Scheme 1 (which produces the lowest premium) values the current term and rent of the tenants’ leases. Therefore the premium is based on the current value of the leases with no additional value being attributable to what may happen in the future or the effect on value of enfranchising;
- Scheme 2 adds “hope value” to the value of the leases to recognise that the landlord has an expectation of being able to realise further value from the property in the future, but it does not take into account any increase in value resulting from enfranchisement having taken place;
- Scheme 3 (which produces the highest premium) broadly retains the current “marriage value” calculation. In addition to the value of the leases, the landlord receives 50% of the increased value of the property by virtue of the leasehold and freehold interests being held together following enfranchisement on the basis that the value of the combined interests is greater than the sum of the individual interests.
There is no right or wrong basis for valuing an enfranchisement claim. The government will need to strike a balance between the interests of landlords and tenants when deciding which scheme to adopt. However, it is likely that the overall premiums payable by tenants will be reduced. The question is by how much.
In addition to the three mains schemes, the Law Commission has put forward additional proposals for the government to consider:
- Should there be prescribed rates that are used to calculate values attributable to the term, rent and hope / marriage value? This would enable on-line calculators to be published so that landlords and tenants would be able to work out the cost of enfranchisement;
- Should there be a cap on the level of ground rents that are taken into account when carrying out the valuation so that tenants of leases with onerous ground rents do not have to pay artificially high premiums?
- Should development value be taken into account? If the tenants were able, for example, to add additional flats in the roof space, should the landlord be able to increase the premium to reflect this. Alternatively, tenants could have the right for development value to be excluded from the valuation if they covenant with the landlord not to develop?
- Should premiums be lower for owner occupiers with higher premiums payable by investors who do not occupy? The Law Commission foresees problems with this approach but leaves it open for consideration;
- If marriage or hope value is used in calculating the premium, should the current 80-year cut-off rule be retained so that the premium is not increased if the lease has more than 80 years to run?
- Should the current discount to reflect the value of tenant’s improvements be retained? The Law Commission believes it should but thinks that the discount needs to be simplified;
- Should the current discount to the premium to reflect the risk of the tenant holding over be retained. Again, the Law Commission believes it should be retained but thinks that it needs to be simplified.
What happens next?
Following the publication of a Law Commission report, the usual procedure is that the government provides an interim response to the Law Commission (within six months), and gives a final response as soon as possible but within a year of the report being published. Landlords and tenants (and their representative bodies) will no doubt want to lobby for their preferred options by making representations to the Ministry of Housing, Communities and Local Government, who will be responsible for the resulting legislation required to implement the Law Commission’s proposals.
There is no clear timetable for new legislation to be put forward. A second Law Commission report on the legal processes involved in enfranchisement will need to be considered when it is published later this year. Changes to enfranchisement are expected to form part of a package of leasehold and commonhold reforms that will take some time to put in to legislative form and proceed through Parliament. However, change is coming and landlords and tenants need to be prepared for it.