Lease Extension Question

Speedbird676

My partner and I have made an offer on a leasehold flat which has 110 years remaining on the lease. The ground rent is currently £300 per year.

We had factored into our purchase that we would probably extend the least at some point in the future and had used The Leasehold Advisory Service's calculator, which gave a range of £6-8k plus costs for a lease extension, which we factored into our offer and future budgeting.

Our solicitor has drawn our attention to a ground rent doubling clause in the lease, whereby the ground rent doubles every 20 years with the first increase in 5 years time. All of the lease extension calculators I've found online state they cannot cater for any rising ground rent.

Does anybody have any experience of what a likely range would be? We're just looking to validate what we'd factored into our offer and future budgeting to assess whether it's still a worthwhile purchase.

PS: We're aware of the £1,000 AST threshold (property is in London), which would affect us in 25 years time, and our mortgage lender has no issues with the purchase, so only looking for advice on the likely lease extension costs - thanks 

eddddy

So just to double check - the ground rent doubles every 20 years for the rest of the lease - so it will have increased to £19,200 per year in 105 years time.


If so, it looks like the lease extension premium would be around £14k to £17k (plus costs).

 

Speedbird676

eddddy said:

So just to double check - the ground rent doubles every 20 years for the rest of the lease - so it will have increased to £19,200 per year in 105 years time.


If so, it looks like the lease extension premium would be around £14k to £17k (plus costs).

 

That's correct - increases in years 21, 41, 61, 81, 101 and 121, so the last five years would be £19,200.

bouicca21

@eddddy What is the formula for the calculation?

eddddy

bouicca21 said:

@eddddy What is the formula for the calculation?

There's a description of the formula here: https://www.lease-advice.org/advice-guide/lease-extension-valuation/

(Or if you're heavily into maths equations, here: https://tartarus.org/martin/leasehold.htm )



But I didn't need to do the whole calculation, as @Speedbird676 had already used an online calculator to calculate the premium for a level ground rent of £300 per year.

Speedbird676

eddddy said:

bouicca21 said:

@eddddy What is the formula for the calculation?

There's a description of the formula here: https://www.lease-advice.org/advice-guide/lease-extension-valuation/

(Or if you're heavily into maths equations, here: https://tartarus.org/martin/leasehold.htm )



But I didn't need to do the whole calculation, as @Speedbird676 had already used an online calculator to calculate the premium for a level ground rent of £300 per year.

Thanks again @eddddy.

Out of interest, what effect does the increasing ground rent have on the calculation? Obviously it increases it but those future increases are presumably intended to keep up with inflation - ie: the £300 we pay today would be worth a lot less in 100 years.

Is it somehow weighted more toward the present day rent, otherwise we're effectively pre-paying inflation when we pay the lease extension premium.

eddddy

Speedbird676 said:

Out of interest, what effect does the increasing ground rent have on the calculation? Obviously it increases it but those future increases are presumably intended to keep up with inflation - ie: the £300 we pay today would be worth a lot less in 100 years.

I don't quite follow your question - so instead I'll explain how the lease extension legislation deals with ground rents. (But I'm only going to talk about ground rent - not the rest of the calculation.)

• As it stands, you have promised to pay your freeholder £300 per year for 5 years, followed by £600 for 20 years, followed by £1200 for 20 years, £2400..., £4800..., £9600... and £19200...

• The legislation tries to determine "If you offered that income stream to an investor today on the open market - how much would they pay today as a lump sum?" (And that's what you should pay the freeholder.)

• In theory, you should ask a RICS valuer with local knowledge of the property market, etc, etc

• But in practice, tribunals usually agree that an investor will expect a return of between 6% and 7% on their lump sum payment

The percentage (6% to 7%) tends to depend on the type of property...

• If it's a huge development of 500 flats, each paying £300pa ground rent - i.e. £150k per year - a big pension company might buy that - and be happy with a 5% or 6% return.

• But if it's just a pair of converted flats, each paying £100pa ground rent - i.e. £200 per year - that's much less desirable - no pension company would be interested in that. So a small investor might want 7% or 8% return to make it worth bothering with.

So I did a calculation... given the income stream from your ground rent...

• What lump-sum would an investor looking for a 6% return pay for that income stream? (that results in the higher figure)
• What lump-sum would an investor looking for a 7% return pay for that income stream? (that results in the lower figure)

i.e. When you reduce your ground rent to zero - you are simply paying the freeholder what an investor would have paid for that ground rent on the open market.

Speedbird676

That makes sense.

I think what I was struggling with, when I read the equation, was where G is variable what value do you plug in. If there was no escalation it would be £300 but as it isn't a fixed value what number is the input for G? It didn't seem fair to me that you would use, for example £19,200, because you'd be "buying out" the freeholder's income stream today at the future value which wouldn't be realised for another hundred years. At one point I put the average of all the ground rents over the remaining £110k into one of the calculators and out popped £60-80k for the extension 

The way you have explained it makes much more sense - to achieve that income stream based on a return of 6-7% what lump sum investment would be required today.

JM68

The doubling of ground rent in that way (and particularly from a relatively high starting rate) is pretty much a scam by modern new builds to get excess profits, not (just) to hedge against inflation.

I predict when you get a professional valuer in and s/he does the calculation you will find, as edddy suggests, the premium you will have to pay will be significantly higher than calculators suggest when using the current £300 figure.

Other things to bear in mind.

- You can't start the process until you have lived there for 2 years, unless the current owner starts the process and assigns it to you.

- In terms of costs we paid around £1,000 for valuation report, £1,500 for legal costs, £1,000 for professional to handle negotiation, plus around £2,500 total for freeholder valuation and legal costs.  Plus IIRC VAT on top of all that.

- The freeholder came back with a stupidly high counter offer and also stretched out the time to end of every deadline, and did not settle until after we had to issue a tribunal claim (but before hearing), which we were advised is very common.

Lastly, FWIW, when we were looking to buy we did not find any vendors interested in reflecting our future lease extension costs into what they were willing to accept (except where it was much closer to 80 years left), so good luck!!!

eddddy

Speedbird676 said:

That makes sense.

I think what I was struggling with, when I read the equation, was where G is variable what value do you plug in. If there was no escalation it would be £300 but as it isn't a fixed value what number is the input for G? It didn't seem fair to me that you would use, for example £19,200, because you'd be "buying out" the freeholder's income stream today at the future value which wouldn't be realised for another hundred years. At one point I put the average of all the ground rents over the remaining £110k into one of the calculators and out popped £60-80k for the extension 

The way you have explained it makes much more sense - to achieve that income stream based on a return of 6-7% what lump sum investment would be required today.

To put things in perspective...

• If an investor wanted a return of 7% - and you promised them one ground rent payment of £19,200 in 110 years time...

• They would only pay £11 for it today

eddddy

JM68 said:

- The freeholder came back with a stupidly high counter offer and also stretched out the time to end of every deadline, and did not settle until after we had to issue a tribunal claim (but before hearing), which we were advised is very common.

I had to go a few steps further with a difficult freeholder. I went to tribunal and got a ruling. But then the freeholder refused to sign the lease extension deed.

So I had to take them to court to get a court order instructing them to sign it.

My legal fees were astronomical.