Extending leases: Why the wealthy win under the new rules

Less well-off owners of leasehold flats may pay substantially more to buy their freehold or extend their leases as a result of a court decision on how the price is calculated.

To buy the freehold, a tenant is paying now for an asset that the freeholder would get back in the future, usually in 30 to 80 years time. To reflect this, the price is set at the amount that would, after compound interest, be the same as the value of the property when the lease expires. This interest rate is known as the deferment rate, and the higher it is, the less the tenant has to pay up front.

The deferment rate has traditionally varied depending on the amount of risk attached to the investment. Leaseholders in a well-maintained block in Mayfair could expect to pay more than people living in shabby terrace houses in the Old Kent Road, on the grounds that buying a Mayfair flat is a sure-fire moneymaker, while the Old Kent Road is a rather riskier investment. For many years, the rate in central London was 6 per cent, but in the regions where leasehold property tends to be at the lower end of the market, rates could be above 10 per cent.

Recently, however, London's big landowners, have brought a number of cases to the Leasehold Valuation Tribunal and have succeeded in getting the deferment rate reduced over several steps to 3.5 per cent.

One such case, Earl Cadogan vs Sportelli, was taken to appeal to the new Lands Tribunal, which issued its judgement last week. Surprisingly, the tribunal raised the deferment rate to 4.75 per cent for flats and 5 per cent for houses, which, on the face of it, is good news for leaseholders.

Robert Orr-Ewing, the head of the leasehold reform department at Knight Frank, says: "This is good news for leaseholders because it has reversed a trend for lower rates over the past two years. Leaseholders will welcome the fact that the judgment puts this issue to rest. It should be easier now to negotiate claims, rather than go to the Tribunal to have them determined."

Orr-Ewing calculates that buying an extension of 90 years on the lease of a £1m flat will now cost around £316,000, about £10,000 cheaper than before the case. Unfortunately, the Lands Tribunal also ruled that the new deferment rates will apply to all leasehold properties, irrespective of location or condition.

"Leaseholders outside London could be substantially worse off," says Angus Fanshawe of Douglas & Gordon. He calculates that the owner of a flat in Dartford valued at £175,000 on an 80 year lease would have cost £1,287 for an extension of the lease before the Sportelli decision. Now, they will have to pay £5,450, an increase of 323 per cent. It goes without saying that the owner of a £1m flat in London is unlikely to notice the £10,000 they save on extending the lease, but an extra £5,000 for the less well-off Dartford tenant is going to be difficult.

Roland Cullum, of Cluttons, believes that if a lease has less than 20 years to run, it will be more expensive to buy the freehold, because the Lands Tribunal has specifically excluded such leases from the standard 4.75 per cent rate.

"The Tribunal said that the generic rates apply to leases with unexpired terms of more than 20 years and have made no comment on what happens where the unexpired term is less than 20 years," Cullum points out. David Goldstone, of enfranchisement experts John D Wood & Co, says the decision is really a victory for freeholders: "The Sportelli decision is fundamentally flawed because it applies the same 5 per cent rate whether dealing with a flat in a prime block in Chelsea or a small flat in a deteriorating block on a main road in a suburban area."

Overall, Goldstone believes, leaseholders have won a small battle but lost the war. "This has, in effect, swung the pendulum back in a small way in favour of all leaseholders, by reducing the cost of buying a lease extension or the freehold of a property," Goldstone says. "However, leaseholders used to benefit from deferment rates in excess of 6 per cent and therefore a much lower cost. Overall, the freeholders have scored a major victory in increasing the cost of buying a lease extension or the freehold."