Status Quo for the valuation of lease extensions continues

In a ruling on 24 January 2018, which will be welcomed by freeholders, the Court of Appeal, ruled in favour of the status quo in its eagerly awaited decision in Mundy v Trustees of the Sloane Stanley Estate [2018] EWCA Civ 35.

The case itself involves a small flat in Chelsea where the lease had less than 23 years remaining and the leaseholder was seeking an extension under the leasehold Reform, Housing and Urban Development Act 1993 at a peppercorn rent for a premium.

The appeal from the Upper Tribunal (Lands Chamber) concerned how that premium is to be calculated and more specifically it concerned the issue of ‘relativity’ in calculating the premium.

There are two aspects to the concept of relativity. First it is used to determine the value of the freehold with vacant possession and secondly it is used to describe the relationship between the value of a leasehold interest in the real world and the value of the same interest on the assumption that the 1993 Act confers no right to acquire any interest in any premises containing the tenant’s flat or to acquire any new lease (i.e. that there is no right to a lease extension or to participate in collective enfranchisement).

The Judgment recognises that the problem with relativity arises because in the real world most sales of leasehold flats are sales of lease to which rights under the 1993 Act attach, whereas the Act requires those rights to be disregarded as part of the process of calculating the premium.

This is not a new problem and over the years a number of methods of determining relativities have been considered by the tribunals, none of which proved to be without flaws. The most common method has been by way of relativity graphs, produced by a number of firms of chartered surveyors active in the market, which plot the relationship in terms of value between a lease of a given length and the freehold. The various relativity graphs differ in their results and Lord Justice Lewison comments in the Judgment that the holy grail would be a method of determining relativity which is both reliable and simple to apply.

The most influential and commonly used relativity graph is the Gerald Eve graph which was described by the Upper Tribunal as the ‘Industry standard’. This appeal sought to challenge the validity of the Gerald Eve graph and proposed the Parthenia model which is based on a statistical technique called hedonic regression which starts from the proposition that a lease of a flat has a value which is made up of many components parts (size, location, physical condition and length of lease). The hedonic regression analysis seeks to isolate each characteristic and give a value to it. The Parthenia model was based on transactions which took place between 1987 and 1991, before the coming into force of the 1993 Act, with the objective of eliminating the effect of the 1993 Act on relativity and claimed that Hedonic regression was the only reliable way of measuring relativity.

The Upper Tribunal had rejected the Parthenia model of relativity in valuing new lease claims under the 1993 Act.

The Court of Appeal upheld the decision of the Upper Tribunal and held that the Tribunal had been entitled to hold that the Parthenia model was “a clock which strikes 13”. This was because the Parthenia model produced an impossible result when applied to the facts of the case. It was accepted that rights under the Act were valuable, however, when using Parthenia it suggested that the value of a lease without Act rights was worth more than the lease was actually sold for, with Act rights.

The Tribunal had also carried out a thorough examination of the Parthenia model at a 9-day hearing, with extensive expert evidence, and concluded that it was flawed and the Court of Appeal determined that there was ample evidence to support the Tribunal’s rejection of the Parthenia model and determined that the Upper Tribunal was entitled to hold that the Parthenia model in its current form should not be put forward in future cases.

The Appellant had also put forward the argument that the market was ‘corrupted’ because the Gerald Eve graph had influenced the market but the Court of Appeal determined that this was an overstatement. The market evidence had to be looked at, even if it was influenced by the imperfect Gerald Eve graph.

The Appellant was also refused permission to appeal to argue that the 1993 Act required it to be assumed that the market was one in which no one had rights under the Act, so that there was a ‘no Act world’ rather than a ‘no Act building’ i.e. that no one in the country had rights under the 1993 Act. The Court of Appeal determined that the Act could not be construed in that way.

Whilst it is clear that the Gerard Eve graph and the other ‘relativity graphs’ are far from perfect, the Court of Appeal’s decision to rule out future use of the Parthenia model (at least in its current form) demonstrates that the Court of Appeal prefers a ‘real world’ approach to valuations with adjustments, where necessary, to take into account the benefit which rights under the 1993 Act would typically add to the valuation of a lease.

The Court of Appeal concluded, however, by noting that at the invitation of the Government, the Law Commission is to consider the simplification of valuations under the Act and in the words of Lord Justice Lewison “it may be, therefore, that the holy grail will one day be found”.

Whether the Law Commission will be able to simplify the valuations under the 1993 Act remains to be seen. Earlier in the Judgment, Lord Justice Lewison commented that the RICS working group were unable to produce definitive graphs that could be used to establish relativities so it will not be an easy task for the Law commission.

Until any such simplification of the valuation process by the Law commission it is clear that if you own a leasehold flat with less than 80 years remaining then the status quo will continue and there will be no major shift in how the premium for a lease extension will be calculated.

Written by David Burns on 30 January 2018.

David Burns is a Partner and Head of the firm’s Enfranchisement and Lease Extension team. He can be contacted on his direct dial 0207 467 5751 and d.burns@rfblegal.co.uk

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