Freehold Valuation

A Freehold Valuation is important to leaseholders seeking to either extend their leases by 90 years or to participate in a collective enfranchisement where they buy the freehold together and then grant themselves new 999 year leases.

So how do you value a freehold?

freeholderFreehold Valuation – The Freeholder

The Freeholder has brought the freehold to obtain an income from the leaseholders.  How does the Freeholder do this?

  1. By charging Ground Rent – This is an annual charge that may stay the same over the length of the lease or increase by set amounts every so often, or could be linked to an index such as inflation or even worse average private sector pay – in fact anything that was put in the original lease.
  2. By making charges for consents and agreements to the leaseholder.
  3. By arranging insurance through the freeholder’s own agency and earning commission on this.
  4. By using contractors owned by or related to the freeholder.
  5. By the eventual return of the property at the end of the lease and then either entering into a new lease or selling the freehold.
  6. At the end of the lease obtaining a higher value for the freehold by using the site for re-development in conjunction with an adjacent site owned by the freeholder.
  7. By combining (or marrying) the ownership of the lease and the freehold.

The freeholder will want to be compensated for the loss of income. In legal-speak: “to be in a no worse position” that at present.

In order to achieve this the law sets out how this must be done. Let’s take the 7 items above and examine each one.

1. Ground Rent

To compensate the Freeholder for loss of Ground Rent the Freeholder will want to receive a lump of cash that can be invested to obtain the same income as the Ground Rent.  Let’s say the Ground Rent is £1,000 per year. The Freeholder will need a larger amount that could be placed on deposit in (say) a bank with the interest received being £1,000.

How much is required to receive an average income of £1,000 each year over say 70 years is anyone’s guess. At present you might be lucky to get 2% interest so would need £50,000 to earn £1,000 in interest. A few years ago interest rates were 10% so you would only need to invest £10,000 at 10% interest to earn £1,000.  Thankfully the Courts have come to the rescue and have ruled (Cadogan v Sportelli)  that the rate to be used should be 5%. So in order to receive an average income of £1,000 each year £20,000 would need to be invested. i.e. 20 times the annual Ground Rent.

2. Charges for consents etc

The Freeholder should only be charging these items at cost and in any event loses the right to charge for any management functions if the leaseholders exercise the Right To Manage. Therefore, no compensation is allowed for the loss of this income.

3. Insurance commissions etc

The Freeholder loses the right to charge for any management functions if the leaseholders exercise the Right To Manage. Therefore, by law no compensation is allowed for the loss of this income.

4. Profits from the Freeholders own or related contractors and work not necessarily required.

The Freeholder loses the right to charge for any management functions if the leaseholders exercise the Right To Manage. Therefore, by law no compensation is allowed for the loss of this income.

5. Return of the property at the end of the lease.

The shorter the remaining term of the lease is the closer the Freeholder will be to having the property returned and being able to sell it or a new lease. Let’s say a site is worth £1,000,000 today. What would the freeholder be prepared to receive for the freehold if there were only one day left on the lease? Probably £1,000,000.

Let’s stretch this out to one year. The Freeholder may be prepared to receive say £980,000 because the Freeholder could take £980,000 and invest it for a year and earn say £20,000 bringing his income in a year’s time to £1,000, 000.

Rolling this back 10 years and it is clear the freeholder will accept an even lower figure as there will be ten years of interest on the amount accepted.

Taking this to an extreme let’s say there are 900 years left on the lease. How much would you pay someone today if he promised to give you  £1,000,000 in 900 years. My guess is nothing 🙂

Typically when leaseholders start to look at the remaining leases terms there are often between 90 to 50 years left. At this length they have a value because the freeholder who is often an institutional investor will find a market for income that will be received that far in the future. Taking the example of a freehold worth £1,000,000. If there are 58 years left on the lease an investor would need £60,000 today to have £1,000,000 in the bank in 58 years time if the bank paid an average of 5% interest over the 58 years.

This in technical terms is called the Reversionary Value. i.e. how much do you need today to end up with the value of the property at the end of the lease?

6. Re-development Value

This normally only applies if the remaining lease is fairly short and the Freeholder could use the land in conjunction with other land owned by the Freeholder. An example could be where the Freeholder owns an adjacent site that can not otherwise be developed as it has no access. However, at the end of the lease term the Freeholder could redevelop both sites together.

7. Combining the ownership of the lease and the freehold

weddingThe “Marriage value” is the term used to apportion the benefit of joining (or marrying) together the freehold tile and the leasehold tile of the property.  So how is this arrived at and when does it apply?

The benefit of joining the two together is difficult to determine. If someone were buying a flat they would pay more for a flat with a share of the freehold attached that will or could have a new 999 year lease. In very general terms this could be about 10% for a lease with about 60 years left to run.

However, the marriage value only applies to the leaseholders’ properties that participate in the purchase of the freehold (collective enfranchisement) as the remaining leaseholders will see no increase in value of their properties as they will still have a short lease (albeit with a new freeholder – i.e. the group of participating leaseholders).

It is important to note that this only applies when the remaining lease term is less than 80 years (a bit like being married for life).

leaseholderFreehold Valuation – The Leaseholder

Having determined what the Freeholder expects how much will the leaseholder have to pay the Freeholder?

1. Ground Rent

To compensate the Freeholder for loss of Ground Rent the leaseholder will need to pay about 20 times the annual Ground Rent as a lump sum. (Future increases in Ground rent are usually ignored unless the increase is due soon.)

2. Charges for consents etc

Nothing

3. Insurance commissions etc

Nothing

4. Profits from the Freeholders own or related contractors and unnecessary work –  i.e. inflated Service charges

Nothing

5. Return of the property at the end of the lease – “The Reversionary Value”.

This technical term called the Reversionary Value is discussed above. The shorter the lease the higher this will be as a percentage of the value of the property. This is where a valuer will be required to:

a) Value the properties. If there are recent sales the leaseholder may already have a good idea of the current market value of a property and when multiplied by the number of properties on the site this will give a reasonable idea of the total value.

b) With the use of tables (or a spread sheet) estimate what the above value for all the properties will be when discounted by the number of years left on the lease.

6. Re-development Value

This will probably not apply but should be checked.

wedding7. Marriage Value

This is the estimated increase in the value of the properties of the participating leaseholders after the freehold has been purchased from the Freeholder split equally between freeholder and participating leaseholders but less the Freeholders’ value of 1. The Ground Rent and 5. The Reversionary Value.

Examples:

Sounds Complicated? Let’s look at some examples…

Beechwood Court – all leaseholders participate

36 flats average property value £70,000 with a remaining lease term of 965 years and Ground Rent of £25 per year (total £900).

  1. Value of Ground Rents = £900 x 20 (years) = £18,000
  2. Reversionary Value of Freehold = £70,000 + increase in value of owning the Freehold (say £600) x 36 (properties) = £2,541,600. But having to wait 965 years makes this worthless. = Nil
  3. Marriage Value as the lease has more than 80 years to run = Nil

Total value therefore = £18,000 (or £500 per property).

Simpsons Court

36 flats average property value £85,000 with a remaining lease term of 81 years and ground rent of £50 per year (total £1,800)

  1. Value of Ground Rents = £1,800 x 20 (years) = £36,000
  2. Reversionary Value of Freehold = £85,000 + increase in value of owning the Freehold (say £2,700) x 36 (properties) = £3,157,200. But having to wait 81 years makes this worth in today’s money about £60,669 (based on a calculation of earning 5% interest every year)
  3. Marriage Value as the lease has more than 80 years to run = Nil

Total value therefore = £36,000 + £60,669 = £96,669 or £2,685 per property if all participate. If only half the leaseholders participate this will increase the cost to about £5,447 per property mainly because the increase in value for the freehold is doubled from £2,700 to £5,400. This is because the participators will also own the freehold the other non-participating leaseholders who will now pay their ground rent and lease extension premiums to the group of participating leaseholders.

Badgers End – 100% participate

12 flats with an average property value of £125,000 with a remaining lease term of 117 years and a ground rent of £150 per year (total £1,800)

  1. Value of Ground Rents = £1,800 x 20 (years) = £36,000
  2. Reversionary Value of Freehold = £125,000 + increase in value of owning the Freehold (say £3,500) x 12 (properties) = £1,542,000. But having to wait 117 years makes this worth in today’s money about £5,116
  3. Marriage Value as the lease has more than 80 years to run = Nil

Total value therefore = £36,000 + £5,116 = £41,116 (or £3,426 per property).

Badgers End – 50% participate

12 flats with an average property value of £125,000 with a remaining lease term of 117 years and a ground rent of £150 per year (total £1,800)

  1. Value of Ground Rents = £1,800 x 20 (years) = £36,000
  2. Reversionary Value of Freehold = £125,000 + increase in value of owning the Freehold (lets say £7,000) [double the previous example as the participating leaseholders will also own a share of the freehold for the non-participators] x 12 (properties) = £1,584,000. But having to wait 117 years makes this worth in today’s money about £5,255
  3. Marriage Value as the lease has more than 80 years to run = Nil

Total value therefore = £36,000 + £5,255 = £41,255 (or £6,875 per property).

Charming Close

30 flats with an average property value of £85,000 with a remaining lease term of 59 years and a ground rent of £60 per year (total £1,800)

  1. Value of Ground Rents = £1,800 x 20 (years) = £36,000
  2. Reversionary Value of Freehold = £85,000 + increase in value of owning the Freehold (lets say £6,400) x 30 (properties) = £2,742,000. But having to wait 59 years makes this worth in today’s money about £154,134
  3. Marriage Value as the lease has less than 80 years to run is £6,400 from 2. above (equal to £192,000 if all the leaseholders participate). From this is deducted the Freeholders’ value of Ground Rents and Revision Value for the number of participating properties. i.e. 1. and 2. above. £192,000 – £190,134 = £1,866 x 50% = £933.

Total value therefore = £36,000 + £154,134 + £933 = £191,067 (£6,369 per property). If only half the leaseholders participate this will increase the cost to about £13,800 per property mainly because the increase in value for the freehold is doubled from £6,400 to £12,800. This is because the participators will also own the freehold the other non-participating leaseholders who will now pay their ground rent and lease extension premiums to the group of participating leaseholders.

Clay Close

36 flats with an average property value of £100,000 with a remaining lease term of 57 years and a ground rent of £60 per year (total £1,800)

  1. Value of Ground Rents = £1,800 x 20 (years) = £36,000
  2. Reversionary Value of Freehold = £100,000 + increase in value of owning the Freehold (lets say £7,700) x 36 (properties) = £3,877,200. But having to wait 57 years makes this worth in today’s money about £240,285
  3. Marriage Value as the lease has less than 80 years to run is £7,700 from 2. above (equal to £277,200 if all the leaseholders participate). From this is deducted the Freeholders’ value of Ground Rents and Revision Value for the number of participating properties. i.e. 1. and 2. above. £277,200 – £276,285 = £915 x 50% = £457

Total value therefore = £36,000 + £240,285 + £457 = £276,742 (£7,687 per property). If only half the leaseholders participate this will increase the cost to about £16,196 per property mainly because the increase in value for the freehold is doubled from £7,700 to £15,400. This is because the participators will also own the freehold the other non-participating leaseholders who will now pay their ground rent and lease extension premiums to the group of participating leaseholders.

Swanbridge Close

24 flats with an average property value of £75,000 with a remaining lease term of 66 years and a ground rent of £60 per year (total £1,440)

  1. Value of Ground Rents = £1,440 x 20 (years) = £28,800
  2. Reversionary Value of Freehold = £75,000 + increase in value of owning the Freehold (let’s say £4,600) x 24 (properties) = £1,910,400. But having to wait 66 years makes this worth in today’s money about £76,319
  3. Marriage Value as the lease has less than 80 years to run is £4,600 from 2. above (equal to £110,400 if all the leaseholders participate). From this is deducted the Freeholders’ value of Ground Rents and Revision Value for the number of participating properties. i.e. 1. and 2. above. £110,400 –  £104,319 = £6,081 x 50% = £3,040

Total value therefore = £28,800 + £79,319 + £3,040 = £107,359 (£4,473 per property). If only half the leaseholders participate this will increase the cost to about £9,123 per property mainly because the increased in value for the freehold is doubled from £4,600 to £9,200. This is because the participators will also own the freehold the other non-participating leaseholders who will now pay their ground rent and lease extension premiums to the group of participating leaseholders.

Gorgeside

12 flats with an average property value of £75,000 with a remaining lease term of 62 years and a ground rent of £25 per year (total £300)

  1. Value of Ground Rents = £300 x 20 (years) = £6,000
  2. Reversionary Value of Freehold = £75,000 + increase in value of owning the Freehold (let’s say £4,500) x 12 (properties) = £954,000. But having to wait 62 years makes this worth in today’s money about £46,325
  3. Marriage Value as the lease has less than 80 years to run is £4,500 from 2. above (equal to £54,000 if all the leaseholders participate). From this is deducted the Freeholders’ value of Ground Rents and Revision Value for the number of participating properties. i.e. 1. and 2. above. £54,000 –  £52,325 = £1,675 x 50% = £838

Total value therefore = £6,000 + £46,325 + £838 = £53,163 (£4,430 per property). If only half the leaseholders participate this will increase the cost to about £9,116 per property mainly because the increased in value for the freehold is doubled from £4,500 to £9,000. This is because the participators will also own the freehold the other non-participating leaseholders who will now pay their ground rent and lease extension premiums to the group of participating leaseholders.

Please feel free to try figures in an excel spread sheet freehold valuation calculator. The results should be similar (but not the same) as the examples above as both are only intended as a guide before professional advice is obtained. The calculator is available here.

Notes:

  1. These examples are provided without any warranty. I am an accountant not a valuer. They give an approximate value based on a number of assumptions. In actual situations the freeholder and the leaseholders will need to negotiate (with the aid of their respective valuers) much like buying a property where the seller aims to get the maximum price and the purchaser pay the lowest possible price.
  2. In addition to the freehold cost or “premium” will be legal fees and valuers fees. If the purchase is a formal purchase under section 13 the freeholder’s reasonable legal and valuation fees will also be payable by the leaseholders. Expect professional fees to be around £2,000 per property.