RDA Estates

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Lease ExtensionsExplanatory Comment On The Relevance Of Lease Extensions To Residential Flats

Background

The subject is fairly technical both in legal interpretation and numeric premium calculation, but essential principles have become well established in recent years.

The leasehold estate, a largely English concept, does have an intrinsic long term conceptual anomaly insofar as property investment has always been seen as a safe long term investment with assets appreciating at least in line with inflation, yet leases are by definition a depreciating commodity as lease terms diminish.

In the early years there is no impact on the lease sale value, and until approx five years ago leases down to as little as 70 years remaining were bought and sold frequently without undue consideration of the reducing term remaining.

However increasingly mortgage companies have increased their requirements on remaining lease term and 75 years is now the required norm. Since most purchases have a mortgage attached to them, it is now commonplace for lease extensions to be required at the time of sale or remortgage for any lease under 75 years. Occasionally cash buyers may prefer to acquire a lease at a discounted cost for whatever personal reason, but such purchases are becoming increasingly unusual. Moreover, conveyancing solicitors are now much more likely to focus on the residual term, even when more than 75 years.

Historically throughout the 20th Century, residential leases were granted for a term of 99 years and virtually all blocks of flats constructed in the property booms of the 1960s and 70s have such a term. In the 1980s time perspectives changed and it became normal for a term of 125 years to be granted on new property developments. A large proportion of the "modern purpose built blocks" in Brighton and Hove were constructed in the late 1950s to 1970s and hence are primarily of the 99 year variety. As such they are now materially impacted by the effect of a depreciating lease term.

Many existing lessees have little or no perspective on the financial significance of extending their lease and investors can find their assumed capital growth somewhat dented, although overall long term growth in values still leaves them in a healthy position notwithstanding the cost impact of extending.

How Much Will It Cost?

The cost of extending falls into two categories, firstly the premium payable to the Freeholder, and secondly the associated professional fees payable.

The former cost should be dictated by a now fairly well established formula involving the current unimproved value of the property, the number of years remaining on the lease, and a defined interest rate normally referred to as the "deferment" rate. This latter rate is exceptionally influential as the formula throws up a future notional valuation at the lease termination date and then discounts it back at the deferment rate as an important part of the formula.

Premium costs do not increase in a straight line basis over the lease term. At up to 80 years remaining, costs are relatively insignificant and that is actually the best time to take an extension. In practice almost no-one ever does because there is no external pressure to consider it. Most valuers now use a graph to obtain a key formula ingredient, often referred to as the uplift factor, based on the remaining lease term available. The graph has been produced by plotting the many hundreds of tribunal determinations in contested cases over recent years, and is therefore considered a more reliable indicator than the rigid fixed reducing pattern previously employed. From 80-60 years the graph assumes a material but steady slope, but from 60 to 45 years it accelerates materially increasing the costs of extending at a more rapid rate. Hence lessees should certainly be advised to think carefully before allowing the lease to decline much beyond 60 years.

Professional costs for extending the lease can vary from under £300 legal costs for registration etc to around £6000 for independent valuers, lawyers and tribunal costs if a situation is contested by the parties and requires to be determined by a Leasehold Valuation Tribunal (LVT). Most commentators regard the LVT route as a fall back to be used where the Freeholder is uncooperative or highly unreasonable, and a negotiated agreement with an informed and sensible Freeholder is far more cost effective for everyone, except of course the valuers and lawyers.

Alternatively a negotiated agreement can be accomplished by a simple two page Deed of Variation which extends the lease term but does not otherwise modify the lease covenants. Such an agreement is simple to effect and achieves the desired result of achieving a satisfactory lease term in a cost effective manner. It is acceptable to the Land Registry which treats the transaction as a new lease and grants a new Title number. Where a mortgage exists the mortgagee will normally require the completion of a Deed of Substituted Security, for which some charge a notional fee.


So Turning To The Critical Question, Should You Extend Or Not And If So Is There An Optimum Time To Do So?

Clearly based on historic cost patterns and rates of investment return, and with the unfailing benefit of hindsight, any lessee acquiring a lease with less than a remaining 99 years, would be best advised to extend at the time of purchase, or after the two year statutory waiting period during which a freeholder has no obligation to cooperate or accept a notice. As already noted, with less than 80 years to run, increasing at an accelerating rate after 60 years, costs and cash flows become a material factor. Several thousands of pounds can become tens of thousands of pounds if left unnoticed and such amounts are invariably beyond the general resources of most owner occupiers and many buy to let investors. It also becomes a matter of financial priority with other competing aspirations.

From a Freeholder's perspective, most are happy to see their reversionary interests growing at an attractive virtually risk free rate with returns way above those they could achieve with alternative investment. Inevitably such an awareness does not provide an inducement to actively promote the sale of extensions to lessees, although some would also argue that to do so across the board could cause unwarranted concern to some lessees, notably retired occupiers without access to mortgage finance. Conversely if the reversionary interest is a good investment to retain by the Freeholder, then logically it is an equally good investment for lessees to contemplate if they reasonably have the resources to accommodate the increased cost.

However every case is likely to be different and must be weighed on its particular merits and the cash flow constraints and aspirations of the lessee. Prior to marketing a leasehold property, Estate Agents may suggest that a lease extension be arranged in advance of a sale, but committing to such a cost pre-sale may be premature insofar as cash buyers of shorter leases still exist, albeit in rather short supply, and if possible it is better to get a committed price from the Freeholder hopefully at no cost which can then be acted on if subsequently required as a condition of sale.

Clearly some less experienced Freeholders may not have the ability to compute the numbers or have direct comparatives from which to work, and in this case they may require that a specialist valuation be undertaken normally at the lessee's cost, typically approx £600 inc VAT.


RDA can arrange for advice from a Leasehold expert for more specific, complex enquiries.

Click here to contact us for a more detailed version of this commentary with the background information to the landmark ‘Sportelli’ decision which was contested via the Lands Tribunal to the House of Lords