warning re capitalisation and deferment rates

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    warning re capitalisation and deferment rates


    Deferment Rate

    In the case of Sportelli the deferment rate is accepted at 4.75% in almost all cases for houses and 5% for flats. The rate is, as we know, derived from the following formula

    Deferment Rate = Risk Free Rate ("RFR") + Risk Premium ("RP") – Real Growth Rate ("RGR").

    Deferment rate = 2.25% + 4.50% - 2.00% = 4.75%

    The RFR – the risk free rate represents the return required by investors when there is no risk of financial loss. It was derived from expert evidence as to the average index linked yields on a five year rolling basis over the decade prior to the hearing of that case. At the time the rate was assessed at 2.25%.

    However since Sportelli index-linked government bond yields increased to a peak in late 2008, during the financial crisis. Yields on indexed linked gilts have then decreased steadily, with quantitive easing . From the spring of 2012, real yields have remained near zero or negative on all indexed linked stock

    In Sportelli it is made clear that the rate used is a long term rate and will not be adjusted simply due to changes which form part of the general economic cycle. However it is becoming more clear that whilst quantitive easing is responsible for some of the fall in interest rates there is growing evidence that the long term rate is likely to remain significantly low for many years. Increased automation in production and pressure on labour costs from the Far East, and in the future possibly Africa, being seen as drivers pushing down household incomes and lowering demand.

    To illustrate just how significant the fall in the risk free rate has been the rate set under Section 1 of the Damages Act 1996 (the Ogden Rate) used in financial settlements has been cut from 2.5% to minus 0.75% a fall of 3.25%.This rate is perodically set and was reset in February 2017 it was last adjusted in 2001. The Ogden rate is the rate used to calculate how much a claimant can expect to earn risk free on a capital sum. The claimant will be very risk adverse indeed because of their circumstances and so it is appropriate to regard this as the risk free rate of return

    The Ogden Rate was 2.5% when the Sportelli judgement was handed down in 2007 stating that the risk free rate should be 2.25. So there was general agreement as to the rate at that time

    Updating the deferment rate with the Ogden Rate

    Deferment Rate = Risk Free Rate ("RFR") + Risk Premium ("RP") – Real Growth Rate ("RGR").

    We could get (0.75%) + 4.50% -2.00% = 1.75%

    And for flats the rate would be 2%

    The effect on the cost of a lease extension is quite simply mind blowing

    On a flat worth £350,000 with an 80 year lease the value of the reversion using 5% would have been £7,061

    If the rate is lowered to 2% then the value of the reversion using 2% would be £71,788

    The difference is £64,727

    Capitalisation Rate

    For capitalisation rates there is no authority to be bound to use the figures used in that judgement.

    The rate is based upon the RFR plus a risk premium.

    The risk premium is made up of the negative financial aspects of ground rent income. The two main items being collection costs and inflation. Other negative aspects include the “hassle factor” in disposing of the investment

    The discount rate used for large ground rents up to the end of last year was around 6% . The RFR was 2.25% as noted above so the sum of the items making up the risk premium is 3.75%

    As a result of the Ogden rate being lowered from 2.5% to minus 0.75% means a fall of 3.25%. Therefore the capitalisation rate for a large ground rent could fall to 2.75%

    A ground rent of £250 per annum doubling every 33 years for a term of 99 years would have a NPV at 6% of £4,902 at 2.75% the NPV jumps to £13,359

    Conclusion

    If you are thinking of extending your lease you need to ask you valuer for their comments on the possible lowering of the deferment rate and capitalisation rate in the light of the Ogden Rate. There is growing evidence and support that the Risk Free Rate may need to be lowered, and even a modest movement down will have a dramatic increase in the cost of a lease extension or enfranchisement. The insurance industry has been very badly effected by this dramatic lowering of the risk free rate and will for certain challenge it. The large estates in London such as Grovenor and Cadogan stand to gain very substantially if the deferment rate was lowered, and will for certain seek to run a test case all the way through the courts.





    #2
    We have had a flat lease extension at Deferment 7% and capitalisation 5%
    are theses the correct rates of Greater London 2019 ?

    Comment


      #3
      Originally posted by desamax View Post
      We have had a flat lease extension at Deferment 7% and capitalisation 5%
      are theses the correct rates of Greater London 2019 ?
      How much did you actually pay for your lease extension ? Could you afford to pay £71K deferment plus £13K capitalisation = £84K for lease extension on 80 years lease ?


      The example in post 1 showed the effect on deferment cost in lease extension using Ogden rate :

      " The effect on the cost of a lease extension is quite simply mind blowing

      On a flat worth £350,000 with an 80 year lease the value of the reversion using 5% would have been £7,061

      If the rate is lowered to 2% then the value of the reversion using 2% would be £71,788

      The difference is £64,727 "

      If the rise in market value after statutory lease extenson is only 10% , from £350K to £385K , its not economic for anyone to extend their lease.

      Comment


        #4
        If the cost of a statutory lease extension was to rise as I outlined then the value of the flat with the short lease would fall to reflect that much larger premium

        Comment


          #5
          Iv stated the % the wrong way round, cap is 7% and Def is 5% is the correct way it should have been. The FH valuer in their calculations state 5% & 5% also their relatively calculating is 5% light of the average according to the graphs of relatively. Do we have grounds to reduce their calculations?
          thanks.

          Comment


            #6
            It is really big difference,compering with past periods

            Comment


              #7
              It is actually long overdue for the interest rates used in these calcs to be adjusted downwards. But I cant see a Tribunal sticking its neck out; it would have to be an appeal decision.

              Comment


                #8
                Lease enfranchisement ..

                Has anyone had the valuation of a flat set lower because of improvements or poor maintenance? Iv seen 5-15k knocked off the extended lease valuation for a new fitted kitchen and bathroom. Also some reductions for poor maintenance. Anyone have any clue how to go about this.

                Thanks.

                Comment


                  #9
                  I suggest a RICS surveyor ( offering lease extension advice ) can give a " valuation " for a flat before its condition has been improved. You may have to approach 2 or 3 locally based surveyors and before deciding which one to pay for a written valuation.

                  Comment


                    #10
                    Originally posted by desamax View Post
                    Lease enfranchisement ..

                    Has anyone had the valuation of a flat set lower because of improvements or poor maintenance? Iv seen 5-15k knocked off the extended lease valuation for a new fitted kitchen and bathroom. Also some reductions for poor maintenance. Anyone have any clue how to go about this.

                    Thanks.
                    The basis of valuation is on the assumption the flat is in lease maintained condition . If it is better than when the lease was granted the lessee can claim tenants improvements and have the value reduced

                    if the flat has been neglected then it is valued as if it had been maintained properly otherwise the landlord loses as a consequence of the lessee breaching the terms of the lease

                    Comment


                      #11
                      Thanks for the replies,

                      all noted. The maintenance I referred to was for the building exterior. Is there also scope for a reduction for 'onerous ground rent'? the ground rent is currently £785 pa (outside London)

                      I understand if it's over £250 its deemed onerous. Iv seen existing lease values discounted by the FTT because of this, how would I calculate how much to take off a 59 yr lease at £785pa worth about 175k (extended)

                      I'm trying to understand how this process works.

                      Thanks again in anticipation.

                      Comment


                        #12
                        A ground rent of £785 per year?? That's more than unusual for a fairly ordinary flat. A word of warning re "the graphs". They are, in the main, out of date, havng been compiled ten years ago, the public and mroe so their lenders are much more concerned regarding lease length than was the case before the global financial crisis. Dont be surprised if settlement occurs somewhere below the average of these graphs. If short lease evidence can be adduced, it trumps the graphs

                        Comment


                          #13
                          [QUOTE=flyingfreehold;n1082904]A ground rent of £785 per year?? That's more than unusual for a fairly ordinary flat.



                          The rent terms of the lease says....
                          'On exchange the rent increase by £50 plus £0.50 per £100 original price 10/2014 £165000. Ground rent is now rent £785.02 pa'. The original rent was £50 at the start of the lease.
                          As stated this is now classes as onerous
                          I would like to know if anyone knows how much the adverse effect on the capital value of the existing lease, that is to say, a purchaser will pay less for the interest when compared to the same property on a lease with a nominal rent provisions .On a property with a market value of 175k with an extended lease.

                          Thanks

                          Comment


                            #14
                            Some have tried to argue that a onerous rent should be capitalised at a higher rate because of the belief that the government will legislate

                            Firstly the valuation has to be done in a no act world so the perceived advantage of the hope the government will legislate has to be ignored

                            the government repeatedly state that any changes to the premium for a lease extension has to have regard to the freeholders human right to adequate compensation . The 1993 Act which establishes the right to extend has been subject to numerous cases and challenges and by now there is a fairly stable valuation methodology to address Human Rights which of course existed at the time of the 1993 Act - so it seems the government has little room to manoeuvre - more likely is the introduction of prescribed rates and capping or abolishing the right for the landlord to recover his costs

                            i think your rent will be capitalised at around 6% based on the following


                            https://assets.publishing.service.go...__Decision.pdf

                            Comment


                              #15
                              If for instance a flat worth 175k on a long lease with a ground rent of £785pa
                              Would the valuation of an identical flat with a ground rent of £50pa or a peppercorn be worth slightly more? If the answer is yes how is the extra valuation worked out?
                              thanks.


                              Comment

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