Lease Extensions within Council owned Freeholds

When you decide to sell your flat, any lease approaching 80 years or below will create difficulties on sale, as a purchaser’s solicitors will regularly advise of the potential cost and difficulty of saleability to their client.

This usually creates a delay, while enquiries are made to your solicitor and then to the Freeholder, who in this case, will advise that they will only entertain a lease extension by a statutory route (i.e. you have to serve a Notice, and this can take up to 9 months to conclude).

These difficulties may result in your purchaser requesting a reduction in price, or more likely, withdrawing from the purchase.

Even if you were to offer a reduction in price, the buyer has no guarantee that they could acquire a lease extension from the Freeholder subsequently, as a flat owner has to have owned the flat for a minimum of two years before qualifying for a lease extension.

The cost of the lease extension will certainly increase, the shorter the lease becomes.

This can also apply when you want to re-mortgage your flat. Increasingly, lenders are insisting on a lease extension when the term has fallen below 85 years.

Therefore, obtaining a lease extension (if your lease is around 80 years, or less) will protect the value of your flat and improve saleability.

Most flats and a few houses in England and Wales are owned under long leases, with long in this instance meaning longer than 21 years.

Because of a legal difficulty in making obligations run with successive owners of the property, the lease is a useful device as every time the property is bought and sold, all of the existing obligations in the leasehold contract are transferred to the new owner.

In shared property, the leasehold contract sets out what parts of the building belong to the leaseholder (usually, but not always, these are the internal parts of the property itself). Normally the structural elements and exterior belong to the freeholder. This person is generally the freehold owner.

Generally speaking, the parts of the building outside the property itself, including the ground beneath it and the space above, belong to the freeholder. The one disadvantage of this system is that a lease is a ‘time limited’ interest in land. Therefore, as time goes on, the length of the lease (and the capital value) diminishes.

The lease is of a predetermined length and will eventually expire. When it runs out, the freeholder can take back the keys of the property. In reality, this day seldom comes because circumstances will force the owner to do something about the diminishing lease (and there are rights to remain in occupation paying a rent). But theoretically, the property will revert to the ownership of the freeholder, who is sometimes called the ‘reversioner’ as a result.

There are no two ways about it. The leasehold flat or house is a wasting asset as a result of the shortening lease. The closer the lease gets to zero years unexpired, the more it reduces the value of the property. Of course, in a rising market, this is more than outweighed much of the time by the appreciation in the value of the property. In a static property market, a diminishing lease will gradually reduce the value of the property, all other things remaining equal.

The right to a Lease Extension is provided by the Leasehold Reform Housing & Urban Development Act 1993 (as amended) and is a grant of an extension to the existing lease term for a further 90 years.  Therefore, if your present lease has 75 years to run, you will end up with a lease of 165 years.

You are also entitled to extinguish your ground rent, so after the grant of a lease extension you pay a peppercorn rent (i.e. zero rent) throughout the entire existing and extended term.

You can now sell or re-mortgage your flat without the lease term or ground rent being an issue.

There are certain criteria, but the main ones are as follows:

1) The lease has to be in excess of 21 years when originally granted

2) You have to have owned the flat for a minimum period of 2 years – however, this may change in forthcoming legislation.

To establish the cost of your lease extension, your valuer will use a term and reversion calculation. Reversion is what happens at the end of the lease when the freeholder is entitled to have the flat back. When a lease extension takes place, this means that the freeholder will not have their flat back for an additional 90 years and they will need to be compensated for this.

To work out what that compensation is, we apply a deferment rate to the current day value of the flat to tell us how much you would have to invest now, to get an equivalent amount at the end of the lease term.

Because of the time value of money, if you had a flat with 80 years left on the lease and it was worth £250,000, using the current deferment rate of 5% you would have to invest about £5,000 now for it to be worth £250,000 in 80 years’ time. So that is how much you are giving the freeholder, to compensate them now, for their loss of reversion in the future.

Because we have not had sight of secondary legislation, we do not know if the deferment rate will stay the same, drop or increase. We cannot possibly say which way it will go, but suggestions in the industry suggest that it will go down (meaning premiums go up), possibly to offset the loss of marriage value for freeholders, in leases with less than 80 years.

Thinking about a Council lease extension, where the lease is over 80 years and the ground rent is only £10, you will not benefit from the marriage value saving or the 0.1% cap on the ground rent at the point of lease extension. If the deferment rate changes, this is what could happen:-

Lease extension premium

With a flat worth £250,000, 80+ years on lease, ground rent of £10 fixed, assume 7% capitalisation rate:-

Deferment rate at 3.5% – £15,521 premium

Deferment rate at 4% – £10,800 premium

Deferment rate at 5% (current rate) – £5,175 premium

Deferment rate at 6% – £2,516 premium

We do not know what the deferment rate will be set at, but you can see that there is a risk that if the rate drops, the premium would increase dramatically. It might be better to proceed under current legislation, as extending your lease could be more expensive in the future. This is entirely up to you though and it depends on your individual circumstances which Austin Gray valuers would be happy to discuss with you.

Going back to the term and reversion calculation, the term part relates to the ground rent. In a similar way to reversion, we are compensating the freeholder for their loss of ground rent over the term. Except that there is a “discount” for buying this out ahead of time. A common multiplier on ground rents ranges between 5-8% depending on the type of ground rent involved and how it reviews.

£10 fixed ground council rents are pretty non-contentious and if the multiplier changes, it is not going to make a great amount of difference, like it would if you had a ground rent of £250 pa, doubling every 10 years.

The Government could set the capitalisation rate lower / higher than is currently agreed between valuers. If this dropped from say 7% to 4% this could increase a premium on flat with 80 years left worth £250,000 and a ground rent that is £10 fixed by about £100.