How is the premium calculated

Calculating Lease Extension Premiums and Marriage Value

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    Lease extensions play a crucial role in maintaining and maximizing the value of leasehold properties. When considering a lease extension, it is essential to understand how the premium is calculated and the concept of marriage value. In this comprehensive guide, we will delve into the parameters used to determine the premium, the significance of the valuation date, and how marriage value affects the overall compensation for both leaseholders and freeholders.


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    Calculating the Premium

    The Capitalization Rate:

    The capitalization rate is a critical parameter used in premium calculations. It is the rate at which future ground rents payable by the leaseholder are discounted to present value. A lower capitalization rate results in a higher premium and vice versa.

    The Deferment Rate:

    The deferment rate is another vital element in the premium calculation. It is the rate at which the value of the property is discounted to present value. The deferment rate considers factors like the remaining lease term and future potential of the property.

    The Relativity:

    The relativity is the ratio of the property’s value with a short lease term to its value with a long lease term. It is crucial in determining the premium, especially in cases where the lease term is shorter.

    Ground Rents:

    The premium calculation takes into account the ground rents payable throughout the existing lease term. The frequency of ground rent changes is considered to arrive at an accurate premium amount.

    Understanding the Valuation Date

    Importance of the Valuation Date:

    The valuation date is the date on which the leaseholder serves the section 42 notice to the landlord for a lease extension. It determines the remaining lease length and is critical in assessing the marriage value, particularly when it approaches or drops below 80 years.

    80-Year Threshold and Marriage Value:

    When the remaining lease term drops below 80 years, the landlord becomes eligible to claim marriage value in addition to the premium. Marriage value is the difference between the property’s value before and after the lease extension. It is shared between the freeholder and leaseholder, with the leaseholder receiving 50%.

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    Calculating Compensation for Lease Extension

    Total Value Calculation:

    The purpose of the valuation is to determine how much compensation the leaseholder needs to pay to all superior interests for the loss they incur due to the lease extension. This compensation allows the leaseholder to extend their lease by 90 years and reduce the ground rent to negligible amounts.

    Discounted Ground Rents:

    The ground rents are discounted using the capitalization rate to assess the investment value for superior interests. This calculation accounts for the financial loss they may incur due to the lease extension.

    Deferment Rate for Freehold Value:

    The freehold value of the flat is discounted using the deferment rate, considering factors like the property’s market potential and other property-specific aspects.

    Example of Lease Extension Premium and Marriage Value Calculation:

    Let’s consider a hypothetical scenario where a leaseholder, Sarah, wants to extend her lease, and the remaining lease term is 85 years. The ground rent payable is £200 per year, and the property’s value with a short lease term (85 years) is estimated at £400,000. The relativity factor is 0.9, and the capitalization rate is 5%. The deferment rate is 6%.

    Step 1: Premium Calculation

                Calculate Discounted Ground Rent:

                      Discounted Ground Rent = Annual Ground Rent / (1 + Capitalization Rate)^Number of Years

                      Discounted Ground Rent = £200 / (1 + 0.05)^85 ≈ £40.66 per year

                Calculate Freehold Value with Long Lease Term:

                      Freehold Value = Property Value with Long Lease Term / (1 + Deferment Rate)^Number of Years

                      Freehold Value = £400,000 / (1 + 0.06)^85 ≈ £54,852.21

                Calculate Total Premium: 

                      Total Premium = (Freehold Value – Discounted Ground Rent) x Relativity

                      Total Premium = (£54,852.21 – £40.66) x 0.9 ≈ £49,348.80

    Step 2: Marriage Value Calculation

                Calculate Property Value with Long Lease Term:

                      Property Value with Long Lease Term = Property Value with Short Lease Term / Relativity

                      Property Value with Long Lease Term = £400,000 / 0.9 ≈ £444,444.44

                Calculate Freehold Value Before Extension:

                      Freehold Value Before Extension = (Annual Ground Rent x Number of Years) / (Deferment Rate x (Number of Years + 1))

                      Freehold Value Before Extension = (£200 x 85) / (0.06 x (85 + 1)) ≈ £141,414.14

                Calculate Marriage Value:

                      Marriage Value = Property Value with Long Lease Term – Freehold Value Before Extension

                      Marriage Value = £444,444.44 – £141,414.14 ≈ £303,030.30

    Step 3: Apportionment of Marriage Value

                      Sarah (Leaseholder) receives 50% of Marriage Value: 50% of £303,030.30 ≈ £151,515.15 Freeholder receives 50% of Marriage                             Value: 50% of £303,030.30 ≈ £151,515.15


    In this example, the premium payable by Sarah for the lease extension is approximately £49,348.80. Additionally, the marriage value of the lease extension is approximately £303,030.30, which is shared equally between Sarah and the freeholder, resulting in Sarah paying £151,515.15 as her portion of the marriage value.

    Lease extension calculations can be complex, and it is crucial to seek professional advice from experts in leasehold valuations to ensure accurate assessments and fair negotiations. Understanding the calculations involved empowers leaseholders like Sarah to make informed decisions and secure the long-term value of their leasehold properties.

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