Cadogan Square Properties Ltd and others v Earl Cadogan

Collective enfranchisement – Leasehold Reform, Housing and Urban Development Act 1993 – Flats – Calculation of premium – Deferment rate – Whether uplift from generic Sportelli rate appropriate where unexpired lease terms less than 20 years and property market near top of its cycle at valuation date – Whether deferment rate for houses not flats to be applied where prospect of reconverting back to single dwelling on expiry of leases – Preliminary issues determined in favour of tenantsEach of the five joined appeals concerned an application by a nominee purchaser, on behalf of qualifying tenants of flats in a building in prime central London (PCL), to acquire the freehold of that building under the Leasehold Reform, Housing and Urban Development Act 1993. The leasehold valuation tribunal (LVT) was asked to determine the premium payable to the landlord in each case. In calculating the value of the freehold reversion for that purpose, it applied the generic deferment rates laid down in Earl Cadogan v Sportelli [2007] 1 EGLR 153 to the vacant possession value to reflect the fact that a purchaser would not enjoy vacant possession until the existing leases expired. The leases had between 15.6 and 17.5 years remaining. In respect of the first, fourth and fifth properties, the LVT applied the 5% Sportelli rate for flats and for the second and third properties it applied the 4.75% Sportelli rate for houses; it accepted the landlord’s contention that those properties should be treated as single dwelling-houses at the valuation date owing to the prospect of their reconversion to that state after the leases had expired.The tenants appealed, contending that: (i) in respect of all five properties, the deferment rate should be increased because the unexpired term of the leases was less than 20 years and the property market would have been perceived to be at or near the top of its cycle at the relevant valuation date; and (ii) with regard to the second and third properties, there was no justification for applying the deferment rate for houses by reference to the prospect of reconversion. Those matters were tried as preliminary issues. The landlord, which also appealed in respect of the first, fourth and fifth properties, argued in favour of the application of the Sportelli rate to those properties.Meanwhile, in a separate appeal hearing before a differently constituted Upper Tribunal, it was decided that the freehold value of the second and third properties should be uplifted to include 15% of the potential development value arising from the possibility of reconversion: see 31 Cadogan Square Freehold Ltd v Earl Cadogan [2010] UKUT 321 (LC).Decision: The preliminary issues were decided in favour of the tenants.(1) The Sportelli deferment rates related to cases in the PCL area where the length of the unexpired term of the relevant leases was 20 years or more. If the lease had an unexpired term of less than 20 years, regard would have to be had to the property cycle at the valuation date. In such cases, the correct approach would be to take the Sportelli formula and consider whether any one or more of its three components, namely the risk premium, the risk-free rate and the real growth rate, should be altered to reflect the position in the property cycle at the relevant valuation dates. The formula was: deferment rate (4.75%) = risk premium (4.5%) + risk-free rate (2.25%) – real growth rate (2%). In the case of flats, an additional 0.25% to reflect management difficulties produced the rate of 5%.(2) In the instant appeals, the parties had produced no evidence to support a different risk-free rate for unexpired terms of less than 20 years, so the Sportelli risk-free rate of 2.25% should be adopted.(3) Although, in the case of real growth rate there was no justification for departing from the 2% Sportelli rate for terms of 20 years or more, it might be appropriate to vary it for lesser terms. With particular regard to the short-term, any change to the real growth rate would not necessarily be cancelled by an equal change in the risk premium. An investor would take an informed view of the short-term growth prospect of an investment and, if it believed that a low growth rate was appropriate because the property cycle was above trend, it would increase its deferment rate accordingly. The deferment rate would change to reflect expectations of the short-term growth rate compared with the long-term trend; this would involve a reasoned identification of the position in the property cycle compared with the long-term trend of value. In the instant appeals, there had been a prolonged period of above-trend growth such that, at the valuation dates, values were in the top half of the cycle. In the short-term, the Sportelli formula could be adjusted to reflect the fact that, at the valuation dates, the residential property market was above its long-term trend line of a real growth rate of 2%. Since the parties’ evidence focused on the real growth rate, there was no advantage or necessity to adjust the risk premium instead. However, an investor would not assume a return to trend by the term date of the leases. Since it was difficult to arrive at an appropriate and economically justified formula to calculate the relevant adjustment to the real growth rates, an overall uplift would instead be applied to the deferment rate to reflect the risk that, at the end of the term, the property cycle would be at a lower level. That uplift was determined by reference to the result that would be arrived at in negotiations between the hypothetical parties so as to reflect market forces at the relevant valuation dates.(4) In 2005, which was the valuation date for the first, fourth and fifth properties, values were considerably above trend and a vendor would not have been able to sustain an argument that growth would continue at its long-term rate of 2%. On the other hand, the purchaser would not have been able to establish objectively that there was no prospect of future growth. Taking those factors into account, the growth rate would have been agreed at less than 2%. On the evidence, the parties would have settled on a real growth rate of 1.75%; accordingly, the deferment rate, based on the Sportelli formula, would be agreed at 5.25%. That was the appropriate rate to apply in respect of those properties.Since the second and third properties had a valuation date in 2007, by which time the market had increased dramatically, a different real growth rate should be applied to them. A purchaser at that time would have been in a stronger position to argue that future growth in capital values would be less than the 1.75% figure that had been appropriate two years earlier. On the evidence, the parties would have agreed a real growth rate of 1.5%; accordingly, the deferment rate would be 5.5%.(5) There was no justification for applying a deferment rate for houses to the second and third properties. The change in the Sportelli rate from 4.75% for a house to 5% for a flat reflected only one factor, namely the possibility of management problems during the unexpired terms. What happened at the end of those terms and, in particular, whether there was the potential of conversion to a single house, was irrelevant to the period before the term date.Stephen Jourdan QC (instructed by Forsters LLP) appeared for the tenants in the first, fourth and fifth appeals and (instructed by Bircham Dyson Bell LLP) for the tenants in the third appeal; Andrew Walker (instructed by Bircham Dyson Bell LLP) appeared for the tenants in the second appeal; Kenneth Munro (instructed by Pemberton Greenish LLP) appeared for the landlord.Sally Dobson, barrister