Short Leases – an opportunity for instant gain?
- For historic reasons, unlike most countries, in England and Wales almost all flats and some houses are held under a leasehold title rather than a freehold one. This article deals with flats although there are similar opportunities for leasehold houses.
- A lease is granted out of a superior title (commonly the freehold) and permits the leaseholder to occupy the property for a set period of time.
- For the purposes of investment, we are talking about leases which, broadly speaking, were originally granted for a term of more than 21 years. These will have a capital value and will generally qualify for a statutory extension of the term under the Housing Reform Leasehold & Urban Development Act 1993 ("the Act").
- The statutory right to extend the lease creates an opportunity to make an immediate profit as well as enhancing the long term investment in the flat.
- In this context, officially, short leases are those which have an unexpired term of 80 years or less but it is those which have an unexpired term of 60 to 65 years or less where a greater opportunity is created because of the restricted market.
How does the potential profit arise?
- The legal right under the Act enables a leaseholder to force a landlord (usually the freeholder) to grant a new lease which has a term of 90 years plus the unexpired term of the existing lease. For example, if a lease was originally for 99 years and at the date of the new lease is granted has an unexpired term of 65 years then the end result will be a new lease of 155 years. The ground rent which is usually payable under a lease (not to be confused with the full rent payable on short lettings) is capitalised and eliminated.
- The price to be paid for the new lease is calculated in accordance with the Act and based on specified valuation principles and assumptions. The key points are:-
- If at the time the claim is made there is more than 80 years unexpired on the lease, then no marriage value is payable
- If there is 80 years or less remaining then 50% of the marriage value must be paid to the landlord as part of the price.
- Marriage value is an additional value created when the lease is extended on the basis that the value of the flat is worth more than the combination of its value at the date the claim was made plus the price paid for the new lease. As a simple example, a flat with an unextended lease with 66 years remaining is worth £1m. The price for the new lease is £80,000. The value of the flat with extended lease is £1,160,000.00. £80,000 is the marriage value. These are illustrative figures only and ignore the costs involved.
- For the shorter leases, even though it is necessary to pay 50% of the marriage value, there is the gain of that other 50% of the marriage value. So in the illustration above there would be an immediate gain of £40,000, less the costs of the exercise. You need to bear in mind that there will often be factored into the price for the shorter lease a ‘buyer’s premium’, particularly in Prime Central London, to take into account the existence of the statutory right to renew. In other words you may have to pay more than the ‘true’ short lease value but there should still be the opportunity for a good return.
- Whilst the opportunity exists to create added value on any extension, particular opportunities arise with shorter leases because of the limited number of potential buyers in the market place. The shorter the lease the more difficult a flat can be to sell and it will be more difficult to use as security for a mortgage. As a result the short lease market is more for sophisticated investors who can either pay cash or can negotiate bespoke funding arrangements with their bank.
- There is a greater opportunity for profit but also a greater risk arises in properties in Prime Central London ( Mayfair ,Kensington and Knightsbridge etc) where the values and prices are much higher. This is also a special market where shorter leases are more marketable than they might be in other areas of the UK.
What does the process cost?
- In addition to the purchase price of the property and conveyancing costs related to the purchase, there will be the price of the lease extension. As said above, this is based on statutory valuation principles and include capitalisation of ground rent.
- There will be the buyer’s own fees, both legal and valuer’s. Estimates should be obtained.
- It is also necessary to pay the landlord’s reasonable costs both for their solicitor and valuer. Where the buyer’s solicitor has full details of the property concerned, of the title and other relevant issues they should be able to provide an approximate estimate of what might have to be paid.
- Unless the property is being bought for immediate re-sale after the extension has taken place, possibly with some refurbishment of the flat, then there will be additional capital tied up in the property.
What are the qualifying criteria?
- The lease must be one which had a term, when originally granted, of more than 21 years.
- The person making the claim must have owned the flat for at least 2 years. There is no need for the flat to have been occupied by the owner/leaseholder and a company as well as an individual can qualify for the right.
- The two year qualifying rule can have a significant impact on the price of the lease extension but there are ways around this:-
- By requiring the seller, as part of the sale contract, to serve the claim notice on the landlord. This claim is then transferred to the buyer on completion of the sale.
- Where the current owner is a single purpose company, by buying the company rather than the property itself. There is then no change of ownership of the property. This assumes that it is possible to buy the company, that this is worthwhile commercially and there is a full understanding of matters such as the tax position.
How long does the process take?
- It can take some 6 – 8 months from the date of the claim. There is a timetable to be followed under the Act which does take some while to go through. It could take longer if the price cannot be agreed and the matter has to be determined by a tribunal, although normally there are only a limited number of cases that get to that stage.
- Of key importance is that the price to be paid for the extension/valuation is fixed at the date the claim notice is given, so any dealing does not affect the price.
What are the risks?
- It is important to assess as accurately as possible the likely costs of the exercise and the benefit to be obtained. It is essential to use a valuer specialising in enfranchisement work to advise on the current value of the property based on the existing lease and of the lower and upper price bands and what is likely to be the realistic end price to be paid for the new extended lease. Although there is a statutory formula, there are a number of elements over which the valuer for the leaseholder and the valuer for the landlord can argue, which include the value of the current interests and comparables and key percentage rates.
- Normally, the price for the lease extension is negotiated but occasionally it is necessary for it to be determined by a tribunal as stated above. If so, there is likely to be a significant increase in costs. The proceedings in the tribunal are, for most purposes, costs neutral which means that each party must pay their own costs for that aspect of the claim.
- Due to the high values involved and some of the complexities, in particular at the top end of the market, the investment is more likely to appeal to someone with a higher risk appetite.
For those investors looking for new investment opportunities, the short lease property market where there are fewer buyers competing for what are desirable properties is well worth looking at. It is necessary to calculate the figures carefully and also to have advice from a specialist valuer and a specialist solicitor. There are a number of legal and valuation nuances and a number of traps for the unwary. These should not be a problem for the well advised investor.
For further information, please contact Christopher Sykes who is a solicitor and director of Sykes Anderson Perry Limited and the author of the Law Society's book "Leasehold Enfranchisement and the Right to Manage".
Please note that this area of the law is a complex subject and you should not take or refrain from taking any step without full legal advice on your particular circumstances. The content of this article is of a general nature and no liability is accepted in connection with it or if any reliance is placed on it.