Olivier A

Registered with Property118.com
Wednesday 24th June 2015

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Total Number of Property118 Comments: 1

Olivier A

22:18 PM, 24th June 2015
About 4 years ago

Freehold value when linked to RPI

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 !... Read More