Earl Cadogan and Cadogan Estates Ltd and others v Sportelli and others

The right to receive ground rent has always been treated separately and is calculated by a process of capitalisation. An additional factor is the need to ascertain the open market value of the freehold interest with vacant possession. This is then adjusted to reflect the fact that vacant possession could not be obtained until the leasehold interest expired. The adjusting factor is known as the “deferment rate.”

Until about 2003, enfranchisement cases presumed a deferment rate of 6% within the prime central London area. In 2003, freeholders began to question this assumption and argued that the deferment rate should fall in line with the yields on other sorts of investments. The Lands Tribunal addressed this point in September 2005, in the decision in Arbib v Earl Cadogan when it rejected the idea that there was a standard 6% deferment rate and stated that 4.5% was the normal rate for houses and 4.75% for flats. Those figures were calculated with reference to the financial markets.

The decision in Arbib raised a number of questions and the Lands Tribunal agreed to hear further cases on the issue of an appropriate deferment rate and the associated issue of the role of “hope value” in enfranchisement cases.

General Principles

The Lands Tribunal stated that, in all enfranchisement cases, it is important to be clear about what the deferment rate represents and the nature of the interests to which it can be applied. There are three elements that must be considered – the right to receive the ground rent; the right to vacant possession at the end of the lease, and the option of realising a share of the marriage value by an earlier sale to the tenant. Each of these elements must be valued separately.

Deferment Rate

The Lands Tribunal approved an entirely new method for calculating the deferment rate which it expressed in the formula “DR = RFR – RGR – RP (deferment rate equals risk-free rate minus real growth rate plus risk premium”.

The risk-free rate is “the return demanded by investors for holding an asset with no risk, often proxied by the return on a government security held to redemption”, which was set at 2.25%, with reference to the 10 year gilt market.

The real growth rate of property has been an average of 2.9% per annum since 1953. However, one could not simply take this figure as, as with all average figures, there was a significant chance that the rate of growth at any particular time could be significantly higher or lower. A fixed figure needed to be chosen if the deferment rate was not to fluctuate wildly. The Tribunal was content to fix the figure at 2%.

The risk premium is “The additional return required by investors to compensate for the risk of not receiving a guaranteed return.” The Tribunal assessed the risk premium by a consideration of the individual components of the risks of investment in long reversions (volatility, illiquidity, deterioration and obsolescence), which formed an overall assessment of the premium that would be required by investors in the type of assets in the present appeals. 4.5% was suggested.
The result is that the deferment rate was set at 4.75%

Additional factors to consider when setting the deferment rate

Although the generic deferment rate was set at 4.75%, the Tribunal made it clear that individual cases with their own circumstances could expect variations from this figure. The most obvious is the length of the remaining term. For any term in excess of twenty years, there was no need to depart from the 4.75% figure. For any terms below this, it will be necessary to have regard to the property cycle at the time of valuation.

The Tribunal accepted that, in an appropriate case, the location of the property could be a factor to consider when assessing the deferment rate but that there was no evidence in the cases currently before the Lands Tribunal which would justify making any such adjustment to the 4.75% figure.

Similar logic was applied to arguments about the condition of the property. It was expected that such factors would make up the vacant possession value and risk premium, but, in an exceptional case, with suitable evidence, it was possible to envisage the deferment rate being impacted.
A 0.25% increase was appropriate for cases involving flats. Even where flats were efficiently managed, the Tribunal felt that service charge and repairs problems would inevitably occur, and the management exercise in itself was sufficiently more complex to warrant a generalised 0.25% addition for flats.

The suggestion that transaction costs should be included in the calculation was expressly disapproved.

Hope value

Hope value, or the option that the freeholder has to sell the freehold or a lease extension to the tenant. Having analysed the legislation in detail, the Tribunal held that hope value should not be included as a separate head of calculation.

Analysis

The Lands Tribunal makes clear in this decision that it is not setting hard and fast rules of law and that each case is, inevitably, a matter of fact and degree. However, the reality is that LVT’s are more likely than not to take on board the comments of the Lands Tribunal in this case and apply them as quasi-orthodoxy. There will be further appeals and further litigation on this issue.
This case is required reading for anyone with any interest in the field of leasehold enfranchisement.

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