Leasehold and Freehold Reform Act: are they having a LAFRA?

Matthew Hearsum and Clive Scrivener consider complications for Labour’s implementation of the Leasehold and Freehold Reform Act 2024. Although the promise in the King’s Speech on 17 July 2024 to publish “draft legislation” on leasehold reform was vague, the explanatory notes published shortly after the speech put a little more meat on the bones. Those notes indicate that, in addition to other reforms, the government intends to prioritise secondary legislation to “implement the provisions of the Leasehold and Freehold Reform Act 2024”. However, this may not be as simple as it appears and, depending on where the government sets the deferment rate, it may make extending leases more expensive, not less. Where the previous government had been stating for years that it would reduce the cost of lease extension, it is likely to leave tenants asking whether they are having a LAFRA. Longer term Currently, tenants are entitled to require the landlord to grant them a lease of the original term plus an additional 90 years for flats, or 50 years for houses. Under the 2024 Act, tenants have the right to require the landlord to grant them a lease of a total of 990 years for both houses and flats. While this does have the positive effect for tenants of negating the need for further lease extensions in the future, in valuation terms, for an average-value London flat with a term of more than 150 years, it will have a negligible impact on the value of the flat – perhaps under £500. Marriage value Marriage value is the increase in the value of a flat as a result of it having an extended, longer lease. This increase in value only arises as a result of the landlord granting a longer lease, and so the current legislation entitles the landlord to 50% of the marriage value released by extending shorter leases (ie with less than 80 years left on the term). This can be a significant amount of money, sometimes in the tens of thousands – or even hundreds of thousands – of pounds for more expensive flats. One of the key reforms in the 2024 Act was to remove the requirement for tenants with less than 80 years left to run on their leases to pay 50% of the marriage value as part of the premium to extend their lease. It is fair to say this change is contentious from the perspective of the landlord and, as a result, it is likely to be challenged in the courts. The most likely argument is that the removal of recovery of marriage value deprives landlords of a significant portion of the compensation payable for a compulsory acquisition of a longer term by the tenant, and therefore infringes Article 1 of the First Protocol to the European Convention on Human Rights. This risk was identified in the legal advice that the Law Commission received in 2019, and the view at that stage was that the chances of success were finely balanced. However, because this change is made by the 2024 Act, which is primary legislation, the most that the courts could do is to make a declaration that the Act is incompatible with A1P1. It is then up to parliament to decide whether it wishes to amend the Act or not. If it does not, it may leave the government open to claims for compensation by landlords. Deferment rate The more difficult battleground for the reforms is the setting of the deferment rate. The deferment rate is a percentage used to calculate the present value of something that will happen in the future. In the context of lease extensions, it is used to calculate the current value now of the landlord’s right to receive the flat back at the end of the term of a lease. Previously the rates were set by the courts and tribunals (5% for flats and 4.75% for houses in Earl Cadogan and another v Sportelli [2007] EWCA Civ 1042; [2007] 1 EGLR 153), but under the 2024 Act they will now be set by the government through statutory instruments. Prior to the general election, in his evidence to the Commons Committee on 16 January 2024, the then Conservative government’s expert Professor Tim Leunig recommended a deferment rate of 3.5%. It is not yet clear whether the new Labour government intends to follow this recommendation. If it does, it will result in a substantial increase in the premium payable to the landlord. This may provide a neat solution to the A1P1 problem arising from the abolition of recovery of marriage value. If the reduction in the premium from the loss of marriage value is offset by the increase caused by setting a lower deferment rate, so that the premium remains broadly the same, the prospect of litigation by landlords may be reduced. Such an approach will result in collateral damage, though, to tenants with longer leases. While those with leases of less than 80 years will benefit from the removal of marriage value, longer leaseholders will not; they will be stuck with the increase caused by the deferment rate, without any saving from marriage value to offset it. Take, as an example, how the change in rate would affect a typical flat in London worth £500,000 with 85 years left on the lease (see box below). The difference in the reversion value between the current rate of 5% and the proposed rate of 3.5% is an increase in the premium payable by the tenant of £18,951. Unlike primary legislation, which cannot be overturned by the courts, statutory instruments (like the one that will set the deferment rate) can be reviewed by the courts and, if found to be unlawful, may be quashed. Prescribed capitalisation rates In addition to setting the deferment rate, the 2024 Act also allows the government to set the capitalisation rate. The capitalisation rate is used to calculate the present value of the right to receive an income over a fixed period of time. It is used in lease extensions to value the present capital value of the ground rent payable over the term of a lease. It will be very difficult to apply one fixed capitalisation rate for all leases. There are many different kinds of ground rents, for example: Static rents, which prescribe a fixed rent payable for the duration of the term (eg £100 per annum for the duration of the term). Fixed increase rents, which start at one level and increase in specified amounts at fixed points (eg starting at £100, then increasing by £50 every 20 years of the term). Dynamic increasing rents, which start at one figure but increase at set points by reference to the capital value of the flat, or the retail price index, or the consumer price index, or something else. Much work to do In our view, the 2024 Act has a long way to go before it can be workable legislation. In particular, there are many difficult decisions to be made around valuation. Crucially, if the deferment rate is set above 5%, freeholders will lose out significantly, with a transfer of wealth to those leasehold owners who have purchased short-lease flats or have allowed their leases to diminish over a long period of time. If the rate is set below 5%, it will make extending longer leases more expensive, not less costly, and therefore fail to deliver on a key purpose of the Act. In our view, the safest course of action for leaseholders with more than 80 years left to run is to extend their leases now, rather than take the risk of the premium increasing if and when the 2024 Act fully becomes law. For leaseholders with leases below 80 years, if they can afford to wait for another 12 months then they might choose to do so in the hope of avoiding paying marriage value; but there is no guarantee that the benefit of this will not be offset by setting the deferment rate at a lower level. However, our view is “better the devil you know”, and leaseholders will be best served by extending their leases now, rather than waiting for the 2024 Act. Matthew Hearsum is a partner in the property litigation team at JMW Solicitors in London. Clive Scrivener is a chartered surveyor at Scrivener Tibbatts Ltd Photo © Adam Vaughan/EPA-EFE/Shutterstock