Doubling Ground Rent Every 21 Years - Section 42 Notice?

aiHandle

Hi All

Considering a leasehold flat in London but found a ground rent doubling clause in lease. Details are:

Lease started at: 2003
Lease term remaining: 983 years
Current ground rent: 150 p.a.
Next ground rent review date: 2024 (i.e. doubling every 21yrs)
Doubling end date: 2129 (i.e. doubling will stop after 126yrs and instead will be either be a percentage of market value or the ground rent amount at that point in time - whichever is higher)

Doubling at this rate would equate to an inflation rate of about 3.4% so I suppose this might be borderline acceptable. However, I am worried about not being able to sell the flat in the future and potential ability to remortgage.

I'm considering asking the seller to serve a Section 42 Notice (to reduce ground rent to peppercorn) but given that the freeholder/investment company has no incentive at all to do this, I'm wondering if

1) There is any limit on what they can set as the premium for the extension? I'm aware via the statutory route that they would have to consider the extension + peppercorn but can they be really unreasonable and demand a really stupid premium to make this option unviable?

2) What would you suggest would be a reasonable premium and what do you think all up it's going to cost including fees etc?

Thanks!

Tom99

aiHandle wrote: »

Hi All

Considering a leasehold flat in London but found a ground rent doubling clause in lease. Details are:

Lease started at: 2003
Lease term remaining: 983 years
Current ground rent: 150 p.a.
Next ground rent review date: 2024 (i.e. doubling every 21yrs)
Doubling end date: 2129 (i.e. doubling will stop after 126yrs and instead will be either be a percentage of market value or the ground rent amount at that point in time - whichever is higher)

Doubling at this rate would equate to an inflation rate of about 3.4% so I suppose this might be borderline acceptable. However, I am worried about not being able to sell the flat in the future and potential ability to remortgage.

I'm considering asking the seller to serve a Section 42 Notice (to reduce ground rent to peppercorn) but given that the freeholder/investment company has no incentive at all to do this, I'm wondering if

1) There is any limit on what they can set as the premium for the extension? I'm aware via the statutory route that they would have to consider the extension + peppercorn but can they be really unreasonable and demand a really stupid premium to make this option unviable?

2) What would you suggest would be a reasonable premium and what do you think all up it's going to cost including fees etc?

Thanks!

[FONT=Verdana, sans-serif]You will pay the market value of the freeholders interest plus both sides costs.[/FONT]
[FONT=Verdana, sans-serif]If you cannot agree you can refer the decision to a tribunal.[/FONT]
[FONT=Verdana, sans-serif]Since you can calculate exactly the ground rent from now for the next 110yrs the only variable in the calculation is the discount rate to apply.[/FONT]
[FONT=Verdana, sans-serif]If you use 6%pa discount rate then the NPV of the rising ground rent is about £7,500.[/FONT]
[FONT=Verdana, sans-serif]Since you are paying their costs the freeholder has no benefit is getting a cheap deal so probably at least c£2,000 for both sides, so budget for say at least £10,000.[/FONT]

[FONT=Verdana, sans-serif]You would normally employ your own surveyor to advise you on value and solicitor to check the section 42 notice to be served by the seller will be valid as you will not get a 2nd chance if it is wrong and will have to wait 2yrs. [/FONT]

aiHandle

hmm.. but would they use the NPV of the ground rent at 110yrs (end of doubling clause) or at 983yrs (end of current lease)?

Tom99

aiHandle wrote: »

hmm.. but would they use the NPV of the ground rent at 110yrs (end of doubling clause) or at 983yrs (end of current lease)?

NPV at 6% for the 1st 110yrs would be about £7,000, if the rent continued to double 200yrs would be £7,430 and 983yrs £7,480 so above 110yrs makes very little difference.
It is questionable whether rent in 111yrs time has any current value even if, mathematically, it should do.

aiHandle

Thanks Tom99

I decided to delve further and try to actually crunch the numbers for myself. I used the examples from

peterbarry.co.uk
[ slash ]how-to-calculate-the-diminution-in-value-of-the-freeholders-interest

peterbarry.co.uk
[ slash ]leasehold-valuation-calculations-2-worked-examples

tartarus.org[ slash ]martin[ slash ]leasehold.htm


to calculate the potential premium, which came to around £4000 (taking into account deferment made a huge difference).

Does anyone know how the "diminution in value" formula is derived? Parts of it looks like the general PV formula but I don't understand where the rest comes from.

So for instance:

1/r-1/[r(1+r)^t ]

simplifies to 1/r * (1 - PV).

But why is there a 1/r multiplier and why is it (1-PV)?

Tom99

aiHandle wrote: »

Thanks Tom99
I decided to delve further and try to actually crunch the numbers for myself. I used the examples from
peterbarry.co.uk
[ slash ]how-to-calculate-the-diminution-in-value-of-the-freeholders-interest
peterbarry.co.uk
[ slash ]leasehold-valuation-calculations-2-worked-examples
tartarus.org[ slash ]martin[ slash ]leasehold.htm

to calculate the potential premium, which came to around £4000 (taking into account deferment made a huge difference).

Does anyone know how the "diminution in value" formula is derived? Parts of it looks like the general PV formula but I don't understand where the rest comes from.

So for instance:

1/r-1/[r(1+r)^t ]

simplifies to 1/r * (1 - PV).

But why is there a 1/r multiplier and why is it (1-PV)?

https://www.peterbarry.co.uk/how-to-calculate-the-diminution-in-value-of-the-freeholders-interest/
https://www.peterbarry.co.uk/leasehold-valuation-calculations-2-worked-examples/

1/r is the formula for YP(years purchase) in perpetuity. So to value £1pa at 8% multiply by 1/0.08=12.5.
The -1/[r(1+r)^t ] part is the same YP in perp but deferred by the term t.
The formula starts by valuing the income in perpetuity then deducts the value of that same income but starting at the end of the term.

The examples in the 2nd link show a rising ground rent similar to your own. With your lease there is no reversion to Open Market Value since the lease is 900+yrs and any reversion is worthless.

The discount rate used will make a big difference to the answer. At 6% its about £7,500 and at 8% about, as you say £4,000/£4,500.

That is why you should appoint your own surveyor who will be experienced in the likely discount rate that could be negotiated.

The fact that the ground rent doubles every 21yrs magnifies the difference the discount rate makes to the end result.

aiHandle

Many thanks again Tom99

So I called around various surveyors and seems like the consensus is that the Capitalisation rate should be around 6.5%. Using this I then ran through the numbers again:

(1) - Using NPV Method

Using excel's NPV function, I basically just passed in all the ground rent flows up until 2128 giving around

6500 @ 6% discounting rate
5000 @ 7% discounting rate

(2) - Using Diminution Formula

Capitalisation rate = 0.065
Deferment rate = 0.05

(apologies for the garbled table...!)

ground rent | valuation | deferred years | valuation after deferment
150 | 623.35 | 0 | 623.35
300 | 3385.49 | 5 | 2652.62
600 | 6770.99 | 26 | 1904.28
1200 | 13541.98 | 47 | 1367.05
2400 | 27083.96 | 68 | 981.39
4800 | 54167.92 | 89 | 704.52

Total valuation after deferment = 8233.21

The valuation via the Diminution Formula comes in pretty high - did I make a mistake in the calculation somewhere?

And would the surveyors calculate the premium using the Diminution Formula or just the NPV?

Thanks again!

Tom99

aiHandle wrote: »

Many thanks again Tom99

So I called around various surveyors and seems like the consensus is that the Capitalisation rate should be around 6.5%. Using this I then ran through the numbers again:

(1) - Using NPV Method

Using excel's NPV function, I basically just passed in all the ground rent flows up until 2128 giving around

6500 @ 6% discounting rate
5000 @ 7% discounting rate

(2) - Using Diminution Formula

Capitalisation rate = 0.065
Deferment rate = 0.05

(apologies for the garbled table...!)

ground rent | valuation | deferred years | valuation after deferment
150 | 623.35 | 0 | 623.35
300 | 3385.49 | 5 | 2652.62
600 | 6770.99 | 26 | 1904.28
1200 | 13541.98 | 47 | 1367.05
2400 | 27083.96 | 68 | 981.39
4800 | 54167.92 | 89 | 704.52

Total valuation after deferment = 8233.21

The valuation via the Diminution Formula comes in pretty high - did I make a mistake in the calculation somewhere?

And would the surveyors calculate the premium using the Diminution Formula or just the NPV?

Thanks again!

They are the same thing. You are calculating the value of the freeholder's interest using NPV. You use a different discount rate for the ground rent (say 6.5%) because it is fixed and a lower rate for the reversion to full Open Market Value (say 5%) because the value of the reversion is not fixed it will increase with house price inflation.

I have not tried to check you figure but you can ignore what you call the deferment rate or reversion rate because that is 900+yrs hence and worthless.

If you put your ground rent into a spreadsheet, one row per year, then discount each year separately and sum them up you get a better idea of how the calculation works.

Discounting your rising ground rent at 6.5%pa comes to about £5,900/£6,300 depending whether you assume the rent is yearly in advance or arrears.

aiHandle

hey Tom99 - thanks a million again for helping out. I think I've finally got my head around it now... I'll try to do a write up later on for a step by step guide to help others... i'm sure these type of questions get asked a million times. All this should really be explained clearly as part of the standard conveyancing process!

bouicca21

A step by step guide would be brilliant. I’m lost at the term ‘discount rate’.

I have 134 years remaining on my lease. Currently £250, then £500 in 2043, ending up capped at £1,000 in 2073. I have absolutely no idea how to calculate the cost of a statutory extension, and would love to have a guide, even though I’m pretty sure it wouldn’t be worth it.

Tom99

bouicca21 wrote: »

A step by step guide would be brilliant. I’m lost at the term ‘discount rate’.
I have 134 years remaining on my lease. Currently £250, then £500 in 2043, ending up capped at £1,000 in 2073. I have absolutely no idea how to calculate the cost of a statutory extension, and would love to have a guide, even though I’m pretty sure it wouldn’t be worth it.

[FONT=Verdana, sans-serif]Discount rate is the interest rate pa at which you defer a future income.[/FONT]

[FONT=Verdana, sans-serif]Lets assume your £250pa ground rent is paid annually in arrears and you would like to receive a 6%pa return on your investment.[/FONT]
[FONT=Verdana, sans-serif]
[/FONT][FONT=Verdana, sans-serif]If you were buying the right to receive the 1st £250pa in 1yrs time you would pay £250x1/(1+r) where r is the discount rate as a decimal.[/FONT]
[FONT=Verdana, sans-serif]
[/FONT][FONT=Verdana, sans-serif]So £250x(1/(1+0.06)=£250x0.944=£235.85[/FONT]
[FONT=Verdana, sans-serif]
[/FONT][FONT=Verdana, sans-serif]Today you would pay £235.85 and in 1yrs time receive the £235.85 plus 6% return of £14.15 total £250.[/FONT]

[FONT=Verdana, sans-serif]Likewise the current value of the 2nd years rent payable in 2yrs time is £250x(1/(1+0.6)^2)=£250x0.89=£222.50.[/FONT]

[FONT=Verdana, sans-serif]And so on for every year of the ground rent.[/FONT]
[FONT=Verdana, sans-serif]
[/FONT][FONT=Verdana, sans-serif]Finally you discount the freeholders reversion to full market value, in your case in 134yrs time.[/FONT]

[FONT=Verdana, sans-serif]Assuming a 5% discount rate for the reversion the formula would be OMVx(1/(1+0.05)^134)=OMVx0.001448.[/FONT]
[FONT=Verdana, sans-serif]
[/FONT][FONT=Verdana, sans-serif]So if today's full market value was, say, £200,000 the reversion in 134yrs time would be worth £200,000x0.001448=£290[/FONT]

[FONT=Verdana, sans-serif]The sum total of all the discounted ground rent payment for the next 134yrs plus the present value of the reversion will equal the NPV(Net Present Value) of the freeholders interest which is the sum you would pay to extend the lease and reduce the ground rent to a peppercorn.[/FONT]