How is the premium calculated?
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The premium is arrived at by using the following parameters:
- The capitalization rate
- The deferment rate
- The relativity
The value of the property (either short lease value or long lease value – or preferably both)
Ground rents payable throughout the term of the existing lease taking note of how often they change.
Each of these parameters have been explained in detail in the previous blog.
One other parameter which can sometimes be very important is the valuation date
What is the valuation date?
The valuation date is the date that the section 42 notice is served on the landlord by the leaseholder. The valuation date is important because this date determines the lease length remaining when the leaseholder requests the extension and also the date that comparable evidence should be based around. It becomes very important when the remaining lease length is approaching 80 years and increasingly more important once it drops below 80 years.
The 80 year threshold is the point at which “Marriage Value” becomes payable to the landlord, in addition to any premium. The marriage value is explained below but it is important to point out that in some cases the marriage value can increase the total premium payable to the landlord significantly.
What is marriage value?
The marriage value is basically the difference between the sum of the values of each of the interests in the property after the extension has taken effect LESS the sum of the values before the extension was even applied for. This value is shared between the freeholder/landlords and the leaseholder. The leaseholder receives 50% of the marriage value and the other 50% is apportioned between the superior leasehold interests such as intermediate lease(s) and the freeholder. The apportionment is decided, based upon the various interests under each superior interest.
Marriage value is very well explained on the following webpage.
The purpose of the valuation is to calculate how much compensation the leaseholder needs to pay to all superior interested parties, for the loss they will incur, in order to be able to extend their lease by an additional 90 years and reduce the ground rent to effectively NIL.
For this to be calculated the total value of holding the lease as an investment for the superior owners needs to be calculated.
The ground rents are discounted at the capitalisation rate and the freehold value of the flat at the deferment rate.
The same calculation is undertaken on the existing interests.
As this is a very difficult concept to comprehend (and to explain simply) perhaps an example of a valuation may help:
|Date of Valuation:||25/03/2010||Capitalisation rate:||8.00%|
|Lease Expiry date:||24/03/2091||Deferment Rate:||5.00%|
|Diminution in Landlord’s Interest|
|YP 81 years @||8.00%||12.4755%|
|Vacant Possession Value||£505,050|
|Deferred 81 Years||5.00%||0.0192|
|New lease value|
|Rent||£0||New lease at Peppercorn rent|
|YP 171 years @||8.00%||0.0000%|
|Vacant Possession Value||£505,050|
|Deferred 171 Years||5.00%||0.0002|
|Diminution of Landlord’s Interest||£10,210|
|Marriage Value||Nil as lease length greater than 80 years remaining||£0|
|Total Premium payable||£10,210|
The above is a very simple valuation with a lease that has more than 80 years remaining and so there is no marriage value payable. But it allows you to see how all of the parameters previously described fit together to form the valuation and how each affects the overall premium.
When marriage value and intermediate leasehold interests are introduced into the mix then the valuations become quite complex. Also, when the reviews of the ground rents are not fixed for the whole period (and so change during the term) or when they are linked to a formula such as the RPI then matters get even more complicated.