The Leasehold Reform Housing and Urban Development Act 1993 sets out the valuation principles used to calculate the cost of lease extension on a leasehold property, usually a flat. The law sets out a complicated process designed to keep things fair for everyone concerned and specifies exactly how the price is arrived at. Here’s what you need to know about the general principles and methods of valuing the landlord’s interest and the role a RICS surveyor plays in the task.
How the cost of an extended lease is calculated
Schedule 13, Part II of the Leasehold Reform, Housing and Urban Development Act 1993 (as amended) says the cost to extend a lease is made up of:
- The difference between the value of the landlord’s interest under the existing lease and the value of their interest after your new lease is granted, with the extra 90 years tacked on
- The landlord’s share of the ‘marriage value’ – in other words the potential increase in the property’s value thanks to the new lease
- The money they’ll lose on ground rent for the remainder of the original lease, simply because the new lease will come with a very low ‘peppercorn’ rent
- The loss they make because of the extra 90 years they’ll have to wait before ownership reverts back to them – also called the reversion date
What the law says about a formal valuation
The law doesn’t insist you get a formal lease extension valuation, but it makes sense to do so simply because the offer you make to the landlord in your tenant’s notice will be based on valuation.
Your landlord can either accept your offer or make a counter-offer via a counter-notice. If you can’t agree on a price between you, either of you can apply to the First-tier Tribunal (Property Chamber), whose members will decide the price on your behalves, making a completely independent decision that doesn’t actually have to reflect the prices suggested by either party.
The idea is that your new lease is calculated the same way as if it the property was sold on the general market. This adequately compensates the landlord for the reduction in the value of their property and also ensures you pay a fair price based on market values.
The principles behind valuation
Valuation is calculated using a variety of known information and assumptions. Your valuer will know basic things like how long is left on the current lease and how much the ground rent is. They’ll use these to pin down the current market value, the likely increase in value when the new lease is granted, and the yield rate – the return the buyers are looking for as regards the market interest in the type of property, of this particular investment quality, in this particular location.
The valuer will use their experience to make their best estimate based on what a buyer would be prepared to pay. This will almost always be different from the landlord’s own valuation.
How about a freehold property with a long lease?
A freehold property with a long lease is usually valued on an investment basis. The only value the freehold interest has is the rental income (also called the term) and the ultimate value of the property when it reverts back to the landlord at the end of the lease. This means the value of the freehold is calculated using the current value of future income – just like many other kinds of investment.
Are there any intermediate interests to think about?
Sometimes your landlord will only have a ‘headlease’. In this case, the freeholder is usually someone else, called the ‘competent landlord’ because their interest in it is important enough to grant your 90-year lease extension. If so your lease extension valuation will need to account for the new lease affecting both landlords’ interests, the immediate landlord and the freeholder. While the price you’ll eventually pay is the same, the money will be shared between the two.
What your RICS lease extension valuation valuer will do for you
A RICS lease extension valuation expert will assess the price of the extension in line with schedule 13, and provide advice about how much to offer your landlord. They’ll advise you about how to react to any counter-notice, negotiate with your landlord for you, and give evidence at the First-tier Tribunal (Property Chamber), if needs be.
Once you have given your landlord your offer, you have to carry on with the process and pay the landlord’s ‘reasonable’ costs, so getting professional advice first is essential. If you need support with lease extension valuations, we’ll be delighted to help.