Ground rent linked to value of property

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    Ground rent linked to value of property

    Hi all,

    Looking for some advice.

    My current GR is £100 pa, but in approx 16 years time will increase to 0.20% of the property value (1/500th as per lease), which is then reviewed at further 25 yr intervals until the end of the lease in c113 years time. So while there is no immediate need to serve a s24 to extend my lease because of length,I need to consider this soon because at some point I will need to buy out the rising ground rent before 2036.

    Does anyone know how you value a flat in 16 years time and then in 41 years time and so on, because that will impact the premium to buy out the lease. I have done my own calculations based on what the property is worth today (c450k), based on a capitalisation rate of 4.5% (am not sure how realistic that is but I can easily change it to 3% and 5% to see the impact on the premium). Reversion to Freehold will obv add additional cost but that won't be a big cost due to term of current lease (113 years).

    The other complication is whether I simply sit on this and wait for the leasehold reform bill which may bring some clarity around cap rates, valuing rising ground rents such as mine.

    I don't think ill rush into doing anything at this point, as its not massively onerous compared to say doubling or RPI ground rents, but I feel it is prudent to get an idea of the cost now to buy out the GR, and maybe then see what happens in the next year or 2 with leasehold reform.

    I could pay for a desktop valuation from a surveyor which I may well do, but thought id canvass opinion here first to see if anyone else has experience of this type of lease cost.

    Any help/comments would be greatly appreciated.


    #2
    You can download a free guide to statutory 90 years lease extension from LEASE website ( www.lease-advice.org ).

    You can use the LEASE calculator to find out the "cost of statutory lease extension" now ( 113 years remaining ) , and 2 years later ( 111 years remaining ) and 16 years later ( 97 years remaining + paying higher ground rent ) .

    Comment


      #3
      No great pearls of wisdom will come from employing a surveyor to work out the premium - they will give you a range of values depending on the capitalization rate and clearly you know how to do it - the ground rent does have a strong element of protection from inflation, but that is dependent on house prices matching inflation - I think over the long term it does if not outperform the RPI

      I would suggest that following the All Saints case, a rate of 3.5% may be more online with the argument you will hear from the other side

      as for leasehold reform, it is likely to be met with enormous pressure from the Great estates and the insurance industry - I think in the end savings to lessee will come from the landlord having to bear all or a large proportion of their own legal and valuation fees - those costs can cost the lessee up to £5k if not more and as you have seen the calculation of the premium requires some mathematical ability but is not that complex and Microsoft Excel has all the formula in it to build the simple mathematical model necessary

      The current ground rent has 16 yrs. to go at £100 – NPV of that rent at 6% capitalization rate = £1,010 (a)

      The rent in 16 years time will be £450k X 1/500 = £900
      Capitalized at 3.5%* ~ Approx = £900 / 0.035 = £25,714**
      Discounted back at 3.5% = £25,714 / 1.035^16 = £14,829 (b)

      Value of reversion = £450,000 / 1.05^116 = £1,567 (c )

      Total = of a+b+c = £17,296

      *Rather than increase the value of the property over the 16 years by an estimate of inflation I have reflected that in the capitalization rate

      **the correct formula is NPV = C x {(1 - (1 + R)-T) / R}
      £900 X (1 – (1.035) ^ -100) / 0.035
      £900 X (1 – 0.3206) / 0.035
      £900 X 0.96793 / 0.035
      £900 X 27.655 = £24,889

      Comment


        #4
        Based on sgclacy's calculation it will probably cost you £20k with legals. If you have that sitting in a regular bank account then you might only get £50pa interest so potentially saving £100pa ground rent isn't a bad investment especially when adding future security.
        If you need to borrow it or have better alternative investment choices then it's a harder decision....

        Comment


          #5
          Adding to what Section20Z comments - your ground rent would be perceived as an issue by buyers and their lenders - the rent being twice the 0.1% limit some lenders have imposed (why 0.1% was chosen is surprising - no articulated study or thoughts have come from lenders as to how this figure was arrived at - my argument is that the larger the rent the less onerous it is because buyers will start to reflect it correctly in their offers - a flat sold for £100k less because the ground rent is say £3000 per annum indexed linked would be a fair deal all round for both the lessee and the freeholder - PROVIDED they understand before hand what they are agreeing to)

          some lenders shy away from rents linked to capital values

          There is a risk in leaving it - it is possible that the deferment rate could well be lowered from 5% to possibly 4% or less to reflect the collapse in the risk free rate since the decision in Sportelli was handed down back in 2006 - since then the risk free rate has fallen from 2,25% to MINUS 0.25% and a review of that rate ie 5% is well overdue - it could also percolate into capitalisation rates particularly for rents that offer protection from inflation

          in conclusion if you are confident that the government will push through its proposed changes to lease extension outlined in January then you should leave it - if you think they will not be successful or are watered down somewhat it mag well be in your interest to deal with it sooner rather than later - if you think you will sell in the next few years you must deal with it now

          i can’t help thinking some of the campaigning groups wanting to outlaw ground rents rather than help lessees has plunged many of them into a mess and unable to sell all because an outgoing of less than half a cup of cofffee in Starbucks a day is seen as a wrecking ball - the reality is that only a very few ground rents cause any problems - if the terms were fully understood at the time of purchase by having the NPV of the rent disclosed next that the premium none of the problems of ground would ever have arisen

          Comment


            #6
            Thanks sglacy and section20Z, very helpful comments.

            So you have used today's value and a lower capitalisation rate to estimate the premium? I guess the alternative approach as you say is to estimate the value of the property and use a higher capitalisation rate but im guessing the premium will be much the same. Is there precedent for either approach?

            Agree, thanks for providing this clarity meaning I dont need to use a Surveyor. Would you say there is a best case and worse case cap rate to use?

            In terms of my situation, I dont need to or want to sell any time soon, in fact ever really, so its not an issue from that perspective. Maybe it will be an issue if I want to refinance, but I have just locked a 5 yr fixed rate. I also have the cash if needed to buy out the GR now, but its a fairly renowned freeholder so I suspect the legals will not be cheap (assume they have to be reasonable though?).

            The only reason I would wait is because the leasehold reform bill deals with both these issues:
            • Capping of the treatment of ground rents at 0.1% of the freehold value. This means that any ground rent due under the lease, exceeding 0.1% of property freehold value at the point of valuation, will be ignored for the purposes of calculating the premium payable for lease extension/freehold purchase.
            • Prescription of rates used for the calculations at market value. When valuing a lease extension or freehold purchase, future ground rent due under the lease is capitalised using a yield rate (the capitalisation rate) to produce a sum in today's money. Similarly, the future value of the property reverting to the freeholder at the end of the lease is assessed using a yield rate known as the deferment rate. The lower the rates, the more punitive for the leaseholder. This reform will fix the relevant rates and remove them as a source of debate between valuers.

            Both would impact the premium massively and there still appears to be a lot of debate re what the appropriate capitation rates are. Obv discounted at 5% the premium would be much less, but I see the counter argument for discounting at 3.5%.

            I also did an informal lease extension and while this was disclosed to me, I guess I didn't understand the true impact of this so in reality it was a 20k mistake (however the alternative at the time was to not extend and I would have probably paid more for the extension due to marriage value). You live and learn.

            My gut feel is to leave it and see what happens because I have the means to buy this out at some point. And surely the reform is not going to put leaseholder such as myself in a worse position (even if I saved on legals that would be a win!)

            Comment


              #7
              sgclacy,

              Re your last comment, I think that is the issue, it wasn't disclosed in that way. Obv I know much moire about it now than I did then, and you learn from your mistakes, but ground rents were historically peppercorn. I do feel this was a sneaky underhand move by the Freeholder because the true extent was just not understood at that juncture.

              Comment


                #8
                Originally posted by ecfc29 View Post

                , but ground rents were historically peppercorn. I do feel this was a sneaky underhand move by the Freeholder because the true extent was just not understood at that juncture.
                No - it is a recurring mistake made by many commentators - grounds rents were most certainly not for very small sums - ground rents on swaths of houses in the north were £1 to £2 per annum at the turn of the twenty century and in today’s terms that is some £200-£300 per annum - I have several property auction catalogues from the early part of the last century. The ground rent was often about 10% of what the passing rent was. Inflation in the seventies lowered many of these rents to very small sums and gives the impression that ground rents were just token sums.

                “sneaky underhand” would be a valid description if the clause reviewing the ground rent was unclear on first reading. Another example is where a freeholder deliberately muddled the words rateable and rentable value or where the start date of the new term is carefully worded to hide the fact it starts from way back in the past so in reality you don’t get the term you think.

                In your case you advise it was a lease extension and the subject matter was on a narrow set of issues i.e. the ground rent the term and its review pattern - you and your professional advisors would have been given the terms in a relatively short document - the term about 1/500th would have been there - so I don’t think it is fair to say it was underhand.

                What makes you think it is “underhand” and illustrates why changes need to be made – but not in my view the abolition of them - is the value of that ground rent steam was not valued by those advising you - in the consumer credit act the APR has to be disclosed. The larger the ground rent then the premium for the lease should fall. Therefore, the ground rent is akin to an interest payment for a discount on the premium payable for the lease. The unfortunate effect of you not appreciating the value the freeholder had created is not the freeholder being underhand but the failure of your advisors and the failure in legislation in not requiring the value of what you were signing

                In a credit agreement the interest is measured and expressed as the APR ( annual percentage rate) and this enables a consumer to appreciate what they are entering into. With a ground rent there is no guidance as to what the total value is of that promise to pay over the lease term that ground rent. This could be so easily addressed by having the NPV of the ground rent shown next to the premium in Box LR7 in the prescribed clauses in the lease. In that way a lessee taking on a new lease can appreciate what the burden is of paying a ground rent and ensure it is reflected in their offer.

                As I wrote earlier, I do not see an issue with a £250k flat ordinarily sold with a modest ground rent being offered with say £150K but with a ground rent of £3,000 per annum linked to the RPI. What needs to happen is that in Box LR7 of the lease the premium of £150k should be shown and underneath it a further sum of £100k is shown as the NPV of the ground rent with a note as to the capitalization rates used – this would be a prescribed figure set from time to time by the Government . Then in Box LR7 the total is shown of £250k. The ten-year doublers would have stood out if such a proposal was in place

                The further problem you have experienced is the collapse in interest rates over the period you have owned your new lease which makes the type of ground rent you have become more valuable – although the value of property may have risen as a consequence of this.

                Comment


                  #9
                  It is a fascinating subject but why do we need to have any annual ground rent payable? Why not keep things simple and just have a lump sum payable for the use of the property over x number of years?

                  Yes it is sneaky and underhand of the freeholder to include terms which do not take effect for many years in the future. The freeholder also fails to spell out the service charges adequately and explain precisely what the purchaser is signing up to and the scams which may apply,

                  Yes, the advisers ought to explain the terms of the lease to the purchaser.

                  Yes the purchaser ought to be aware of what he/she is agreeing to, unfortunately it is rare to consider what may happen in 16 years time, it is not usually considered to be the purchaser's problem. .Also to be fair,, the purchaser is usually told that the lease has been worded in a standard and consistent manner with other leases and it cannot be changed at the time. The purchaser is then faced with accepting the terms or walking away, but by then costs have been incurred and the purchaser is pressurised into signing an agreement within a short time span or losing a deposit and writing off the costs.

                  Yes, the legislation should be changed, but do not hold your breath, there have been reviews in the past and the powerful groups of ground rent owners have succeeded in preventing change from taking place,

                  You may wish to lobby your MP and seek support for change.

                  Comment


                    #10
                    I think what adds to this is that the original lease had a peppercorn rent, so when the new lease was offered/issued the terms were amended to create this additional value with no disclosure of what that future value was. It was actually disclosed to me by my Solicitor, but he basically disclosed it on the value of the property at that time so when I was told the GR would increase to say c600 pa in 25 years, it didn't sound so bad.

                    The reality is its not that bad, its just not ideal!

                    I'd also make this point. Why were freeholders given carte blanche to amend the terms for an informal lease extension, especially when the statutory route dictates that ground rents are reduced to Peppercorn. This is a classic case of lack of regulation on that side - or a case that the regulated route is fair where as the unregulated route is not. So why would anyone choose the latter?

                    Had the rising GR been part of the lease in first place, one could argue in favour of the freeholder, but when I say sneaky and underhand, I mean the terms were purposely amended to create future value that wasn't part of the original lease, as they knew the value they were creating and I didn't.

                    Sgcleary - you make some good points and I'm certainly not crying victim here, I've accepted it was an error on my part and ill bear the cost of that error if I have to. But as Eagle2 says, sometimes you're in a situation where you just accept these things because there is no alternative - in my case if I hadn't extended the lease I probably would have had to pay a much higher premium 2 years later due to the marriage value as lease was sub 80 years.

                    I do agree that property values should reflect the lease terms, so if there are high ground rents, values would essentially be lower to account for this. However, in reality, that is far from the ideal home ownership model, and those properties would be much less desirable.

                    Comment


                      #11
                      I think a letter to my MP is a good idea.

                      Comment


                        #12
                        As I mentioned earlier a ground rent is on a sense an interest payment in return for part of the consideration for the property . In credit agreements you have the APR quoted and I believe the NPV of the ground rent should also be stated

                        a credit agreement can only be brokered by a regulated person and therefore a lease extension reserving a ground rent should perhaps be only available from a regulated person who has to show for example what the statutory cost will be and contrast that to alternative offers quote NPV of these other offers so the lessee can take financial advice on the options

                        Comment


                          #13
                          Exactly, and with the number of banking remediation projects since 2012 (PPI etc etc) this is another example where proper disclosure needs to be considered, and inadequate disclosures addressed through a remediation exercise. Easier to go after the banks though isn't it.

                          Comment


                            #14
                            One of the proposals is to cap ground rents in an enfranchisement claim/lease extension claim. So in theory if the initial rent was say £350 rising by the RPI this would be trimmed back to £250 and any future rises ignored

                            Trying to view this objectively, it does seem somewhat of an ambitious bit of meddling by the government, one can understand them wanting to deal with clauses where the review is difficult to understand but on the example above I have just outlined, why should the government be prepared to face the inevitable challenge in the European Court of Human Rights to lower such rents ? What sort of message does it out to other contracts agreed in the UK.

                            A lessee is represented by a solicitor and a surveyor and can at least be expected to understand what the initial rent was and that must surely stand. The indexation is a reasonable proposal as it attempts to preserve its purchasing power. Doubling at 25/33 years are crude attempts to try and preserve the value of the rent over time and perhaps should be varied to RPI

                            With regard to 10 year doublers I do wonder that the efforts by the CMA are motivated by the fact that the government realizes that it will be very difficult to lower existing agreed rents. The government has promise to do something, so it can now point to the work done by the CMA to show that it has taken action.

                            Another pointer is that the new ground rent bill allows an existing rent ( even if above £250 ) to be carried over into a new extended lease for the remainder of the existing term. If the government were certain of their ground they would have proposed that the new rent carried over would be limited to £250 pa fixed.

                            It is for these reasons and knowing that there will be a very strong backlash from the Great Estates in London and the insurance industry that the government proposals will be watered down. I would guess the likely reforms will be the following:-

                            1) Prescribed rates to make the valuation easier quicker and cheaper ( in terms of professional fees)

                            2) Landlord to bear his own costs / or are capped

                            3) Marriage value abolished - to make the calculation easier and quicker but the deferment rate to be set at around 1% lower than currently used i.e. 4% - that more or less gives the freeholder the same price for a lease extension or enfranchisement . However this could have a detrimental effect on those with lease just over 80 years

                            On a statutory claim where perhaps the lease is above 80 yrs , lessees can easily pay around £5,000 to £6,000 in professional fees for their advisors and that of the landlords . The premium might well be £10,000 - wholly disproportionate and when you appreciate what is involved it is outrageous. A flat with an 80 year plus lease on an estate with others is fairly easy to value to within £5k and the calculation involved in capitalising the rent and valuing the reversion his hardly rocket science and the deed of surrender and regrant could be reduced to a page and half on a prescribed form – it is not £6,000 worth of professional input

                            Comment


                              #15
                              Any reform should benefit leaseholders in some way, but as you say it is likely to be watered down from current proposals. I think the Gov realise this needs to be sorted asap so hopefully will be agreed soon.

                              Considering my situation, 1&2 will help significantly in terms of cost especially considering I have a 115 yr unexpired lease and the ONLY reason for issuing a stat extension now is to remove the ground rent provisions (there is no other reason with a 115 yr lease). So I feel that is fair.

                              As I've said I will bear the cost if I have to but its a kick in the teeth to pay legal costs when in reality I shouldn't need to be extending with an unexpired 115 yr term.

                              Thanks again for your help, it has helped with my decision and at least given me an idea of liability.

                              Comment

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