Freehold value when linked to RPI

by Readers Question

3 years ago

Freehold value when linked to RPI

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Freehold value when linked to RPI

I have a small one bed property, which is currently on a 70 year lease and I need to sell quickly.

I’m in the process of negotiating a lease extension deal with my Freeholder. The deal as a whole seems quite fair at a premium of £5750 and ground rent set to £200 pa, but they want to add a clause in my ground rent where the amount increases from £200 by a further £200 every 15 years, or by the increase in Retail Price Index, whichever the greater.

What I would like to know is how the future value of the freehold will be calculated, so for instance if within the first 15 year period, whoever buys the property, If they decide to formally serve notice for a 90 year extension with peppercorn rent or partake in collective enfranchisement before the first rise in ground rent, will the value be calculated using the £200 increments as stated in the lease or can they use historic RPI data to get a figure??

Hope that makes sense 🙂

DanRPI



Comments

Neil Patterson

3 years ago

Hi Dan,
The Office for National Statistics (ONS) hold all the historic data for RPI month on month year on year going back to 1948.

It would therefore be relatively simple over a 15 year period to calculate what the increase would have been based on RPI. Therefore you will likely be charged which ever is the greater in this scenario

To revalue a sum of money between two periods in time
adjusting to the RPI use the following formula:
Sum of money times (later date index divided by earlier date index)
e.g: £100 X (228.1 [2012]) /206.5 [2008] = £110.46

Dan Haines

3 years ago

Reply to the comment left by "Neil Patterson" at "24/06/2015 - 15:46":

Thanks Neil, yes i am already aware of this. What i was unsure of is how they calculate the value of the freehold if future RPi figures are unknown? I'm assuming they will most likely just use the rising £200 base figure, but wasn't sure if "potential" RPi increase would play a part in the valuation?

Neil Patterson

3 years ago

No you can't predict future RPI or you would be very well paid by the Bank of England lol.

Olivier A

3 years ago

Hi,
I'm a financial markets professional. Perhaps I can explain how I would see this.

Please bear in mind that I'm not a financial adviser, so this post is not "advice" or a valuation and should not be relied on as such. This also may not be consistent with how a surveyor or LVT would value it.

There is an "inflation swap" financial market where banks exchange future inflation linked payments versus a premium. Think of it as the bookmaker's odds for inflation. And the Bank Of England definitely looks at it !

Long story short:
If I were in your position, I would say to the freeholder that their proposed formula is too complex for you to value, unsuitable for a homeowner and that they should send you an alternative proposal with a simpler formula, such as a premium, fixed rent, or fixed increases.

The longer explanation:
I would try to value this proposed rent as follows.

Current market conditions in the "RPI inflation swap" market:
15y rate: ~ 3.4% annualised
30y rate: ~ 3.5% annualised

15y increase
The proposal is the higher of doubling the rent and inflation rate increase.
Doubling the rent in 15y is equivalent to ~4.7% increase annual ( 1.047^15 = 2 ).
4.7% > 3.4% so it's the "doubling" part that will most likely bite.
However the option to have the higher of both is worth more than either, so you should adjust up the rate 4.7% rate up when valuing it. Some complex financial calculators allow to estimate this "option", which will be worth in the order of an additional +0.2% in current conditions.

30y increase
The proposal is the higher of tripling the rent and inflation.
Tripling over 30y is equivalent to 3.7% increase annual.
So again it's the "tripling" part that is most likely to bite but by a lower margin.
Again you will need to adjust for the "option" to get the final equivalent increase rate.

And then now that we have worked out equivalent pound payments we can "discount" them using the implied discount rate on freeholds recently sold.

Now obviously if inflation rates go to 10% like in the 80s the picture above will be very much different and much more in favour of the freeholder !

As you can see from this long explanation, this is relatively complex and impossible to calculate properly for most home owners or surveyors.

In addition please bear in mind that this formula might be considered too complex by your buyer's mortgage lender, defeating your purpose. See point 5.14.9 in the CML instructions for solicitors: https://www.cml.org.uk/lenders-handbook/englandandwales/

Hope this helps !

patrick maher

3 years ago

Why not just put the property on the market, making it known to buyers that it will have a 99 year lease? I wouldn't have thought they or their lenders would care much about how much the ground rent will be increased in the future. If they do you can renegotiate the ground rent terms. The lease extension can be completed simultaneously with the completion of the sale.

Puzzler

3 years ago

I would consider the lease terms very carefully if I were the buyer. When I was younger and knew very much less I would not have considered it.

Why don't you apply for the lease extension through the statutory route (assuming you are eligible)? It takes longer I believe but you do not need to see it through, you sign the option over to the purchaser. Since they will have to pay the premium they will probably expect that to be reflected in the price.

Dan Haines

3 years ago

Reply to the comment left by "Puzzler " at "26/06/2015 - 09:26":

Because the overall cost of the statutory route is somewhere in the region of £11-12K and could take months. The proposed "informal" deal works out at £7250 all included and can complete in 4-6 weeks.
As well as having to sell quickly, we need all the equity we can get in order to put the deposit down on a new place, so out of the two options the informal offer is the more attractive to me. I hope this doesn't sound unethical, but I dont want to reduce the asking price just to make someone elses life cheaper and easier. If the property will easily sell under the informal terms then its a no brainer really.
I agree, with all this hindsight, personally i would never jump into another lease unless it was heavily in my favour, but the chances are, with it being a one bedroom flat, the buyers are most likely to be young and not quite so experienced, and really its up to their solicitor to advise them.

Dan Haines

3 years ago

Reply to the comment left by "patrick maher" at "25/06/2015 - 09:31":

a good idea, but the offer we have received is on a time limit. If the extension doesn't complete within 3 months (issued 2 months ago) then the offer needs to be re-evaluated with a new valuation by the freeholder, which will cost more, and the lease will then have ticked down to 69 years, which will also add more money to the cost.

patrick maher

3 years ago

Dan,

You say you need to sell quickly. I assume you've put the property on the market but not got a buyer yet and that the agent or someone has told you you need to get the lease extended before you can sell it. I think it would have been more normal to find a buyer first and then contact the freeholder for the cost of extending the lease and then your solicitor would check with the buyer's solicitor if he was happy with it.
As it is, why not suggest to the freeholder that he should choose one or the other way of increasing the rent, and to have the best of both worlds is unfair and unreasonable and probably unacceptable to any buyer. If he still does not relent, I would be inclined to wait till the 3 months is nearly up and then accept his offer as it is.


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