Lessons in leasehold: RICS’s new guidance note on valuing residential properties

RICS has issued a new guidance note on valuing residential leasehold properties for secured lending purposes. Sebastian Deckker looks at the detail and offers tips on best practice. Leaseholds have been around since the London estates were developed during the 17th and 18th centuries in conjunction with speculative builders. Despite the recent criticism, we would not benefit from the squares, crescents and terraces we enjoy today if not for this system of land ownership. However, times have changed and, following the introduction of the Leasehold Reform Act 1967 and the Leasehold Reform, Housing and Urban Development Act 1993, freeholds or virtual freeholds have become more common. These Acts, together with recent case law, are designed to enable leaseholders to secure a lease extension, leasehold enfranchisement or, in the case of groups of leaseholders, collective enfranchisement. Valuers should be aware of the different provisions in this legislation. Context for the guidance note With this in mind, the RICS has issued a guidance note – Valuation of residential leasehold properties for secured lending purposes (1st edition, May 2021) – which became effective on 1 July. According to the RICS, this document attempts to “highlight the issues involved in valuing leasehold properties for secured lending purposes in conjunction with the lender requirements; the focus is on the challenges faced when valuing flats in line with the restrictions of a typical lender’s valuation reporting policy”. It is therefore directed at the valuation of properties that may qualify for rights under leasehold reform legislation. It supplements the overall valuation standards laid down in the Red Book Global Standards, including the UK National Supplement. It is a guide to the valuation of leasehold properties for secured lending purposes, in particular those that have an unexpired lease of less than 80 years, when “marriage value” becomes payable producing a material impact on market value. Typically, where remaining lease terms are longer than 100 years, very little impact on value is assumed compared with a long lease or a freehold property, although this will depend on the lease terms and the market. The problem is that there is a general lack of knowledge and an element of suspicion about leaseholds, especially in light of the leasehold house ground rent scandal, and how the value reduces as the term depreciates, for example, the difference between a 95-year lease and a 90-year lease is relatively small in percentage terms but as the lease decreases, that five-year gap between, say, a 12-year lease and a seven-year lease can be significant, in principle becoming valueless when the lease expires – although in reality this is seldom the case. Best practice As should already be standard practice, but now reiterated in the guidance note, when conducting the valuation of a leasehold interest, a copy of the lease should be obtained which contains: The term of the lease, thus providing the unexpired term as at the date of valuation. This becomes more important the shorter the unexpired term but be aware of the original term. For example, a 15-year lease where the original term was over 21 years will have a very different value to a 15-year lease where the original term was, say, 20 years, as can often be seen in central London, thus not qualifying under leasehold reform legislation. The ground rent payable together with any review mechanism. Ground rent is the annual charge payable to the freeholder and can range from a peppercorn or a dozen red roses to tens of thousands of pounds; and the level can have a significant impact on value. The main clauses to look out for are: a) the level of ground rent; and b) the frequency and basis of any periodic reviews. The review can fall into three basic categories: – No review, ie fixed for the term; – Fixed review, eg doubling every 25 years; – Uncertain review, where the ground rent is based on another factor, eg a percentage of the market value or market rent of a property on various assumptions. Restrictive covenants. These can have a significant and substantial impact on the use and thus the value of a property. Conditions for alteration and assignment. There may be charges payable for consent. The level of the service charge and presence of a sinking or reserve fund. Service charges are collected for the maintenance, insurance and repair of a building and the communal areas, and the employment of staff and management of the property. Service charges can vary each year, and a sinking or reserve fund is often established to provide a capital sum to contribute to, pay for and mitigate any planned or unexpected outgoings. The amount payable will depend on the size of building and facilities offered – passenger lift, resident caretaker, communal garden, swimming pool, etc – and again can vary from several hundred pounds a year to thousands. What is not contained in the lease and should be obtained from the managing agent or freeholder are details of: future costs, such as planned maintenance, repairs or major works; level of buildings insurance; and more recently that a fire risk assessment has been completed and an EWS1 form issued if applicable (Taking cladding into account in valuations, EGi, 20 April 2021). Valuers should consider the impact on value caused by cladding and external wall systems when valuing certain types of leasehold property. Remediation costs can be significant and could potentially have a material effect on value. Why this matters The guidance note is helpful in consolidating best practice in respect of residential properties. This is significant, since it is estimated that around a fifth of the total housing stock in England comprises leasehold properties, and the Leasehold Knowledge Partnership estimates that around 100,000 homebuyers are trapped in contracts with spiralling ground rents making their homes unsaleable. As can be seen above, there are numerous factors that can have an effect on the value of leasehold properties and it is down to the valuer to make the necessary investigations and analyse the data – both of which are fundamental to producing a sound valuation. Sebastian Deckker FRICS is a director in the valuation department at Savills Photo © Design Pics Inc/REX/Shutterstock