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Buying Your Freehold - How Much Will It Cost?
05 12 2006
The process of buying your freehold is a complicated one, and the Law that governs the process is generally what makes it so complicated.
One of the most important aspects of any tenant's decision as to whether or not to take up their right to buy their freehold is how much they will have to pay for it.
This short article is aimed at giving you a better idea of the elements that make up the premium you will have to pay if you buy your freehold. It is not a comprehensive guide (the Act is too complicated to go into detail here), and we always recommend to our clients that they get a report from a suitably qualified and experienced valuation surveyor before they embark on the process. ODT will always be happy to recommend a dependable and skilled surveyor in your local area.
A) Background
It is important to bear in mind that the Law gives tenants the right to buy their freehold in certain circumstances, regardless of whether the landlord has done anything wrong. The aim of the rules that govern the amount tenants have to pay is therefore to properly compensate the landlord for the loss of an investment, as a result of the landlord being forced to sell the freehold to the tenants.
B) Valuing the Landlord's Loss
Because the landlord is forced to sell his investment, the Law aims to single out those main areas of income that the landlord can reasonably expect to receive during the time in which he owns the freehold. Broadly speaking the most important of these are:
1. Loss of Ground Rent;
2. Loss of landlord's ability to take the flat back at the end of the lease; and
3. Loss of the right to charge the tenant a premium when he or she eventually requires a lease extensions ('Marriage Value')
We will have a quick look at these in turn.
i) Ground Rent
If the tenants weren't able to buy their freehold, the landlord would expect to continue receiving ground rent on each of the flats in the block until the leases come to an end. Therefore if the tenants buy their freehold at a time when the leases have 70 years left to run, the landlord is being deprived (potentially) of 70 years' worth of ground rent from each flat.
Of course there is a huge benefit to any landlord in being compensated for this loss by way of a lump sum when the purchase goes through, rather than piecemeal over 70 years. Therefore the first job of the surveyor will be to 'cap(talise' the total loss of ground rent, so that the benefit of having all that money up front is properly recognised. Naturally that lump sum will be considerably less than the total amount due over the next 70 years!
ii) Loss of the Flat at the end of the Lease
Again, if the tenants weren't able to buy their freehold, at the end of your lease, the flat would become the property of the landlord once again. Needless to say that this is a valuable asset.
The value to the landlord of taking your flat back at the end of your lease is what lawyers and surveyors call the 'deferment rate'. A recent Lands Tribunal decision has had a huge impact on the way in which this element of the value is calculated, but put simply, the deferment rate can be explained as follows.
Say that the unimproved value of your flat is £150,000, and that there are 80 years left on your lease. The value of the asset that the landlord expects to be coming his way when the lease ends in 80 years time is £150,000.
Broadly speaking (and please note that this is a gross over simplification for explanation purposes), the job of the surveyor is to take the accepted rate of return expected by landlords (currently 5% as a result of the Lands Triunal decision referred to above) and to calculate how much money the landlord requires as a lump sum today, so that if he invested it at 5%, it would grow to £150,000 in 80 years time. This will be the second element of the premium the tenant has to pay.
iii) Marriage Value
Marriage Value is a complicated concept, and generally speaking is the amount of increase in value in your flat that comes about when the leasehold and freehold interests merge. Another way of expressing this is the loss to the landlord of the right to charge a premium when you need a lease extension. This can be demonstrated as follows.
If a tenant has 70 years left on her lease, and she and her fellow tenants decide not to buy the freehold, at some point in the near future, she will have to approach the landlord for an extension of her lease. When this happens, the landlord will charge a large premium for agreeing to do so.
However, if this tenant decided, with her fellow tenants, to buy her freehold first then she would be able to grant herself a lease extension free of charge when the freehold purchase completed. In this way, she will have deprived the landlord of being able to charge her a premium on the lease extension, and it is this ability that causes an increase in the value of freehold to the tenant and is what we call 'Marriage Value'.
There are two important pieces of information to note and they are firstly that there is no marriage value payable on flats with more than 80 years left to run, and secondly that the landlord is only entitled to one half of this increase in value.
iv) Compensation
There is one final element to the premium calculation and that is called compensation. It is not often payable and will arise where the landlord suffers some detriment to other property owned by him as a result of having to sell the freehold to the tenants.
We hope that this whistle stop guide to the way in which freeholds are valued has been useful. As we have already said, this is not intended to be a comprehensive guide and your surveyor will be able to expand on these principles for you when you take the decision to buy your freehold.
More information regarding buying your freehold can be found on the website.