The Supreme Court confirms on the valuation methodology of rent reviews under ground leases (also known as Glasgow leases), in the final episode in Mandic v Cornwall Park Trust Board.

This long running battle regarding the correct interpretation of the rent review provisions under a residential Glasgow lease has ended with the Supreme Court upholding the correctness of the traditional method.

What is a Glasgow lease?

Under a Glasgow lease the lessee leases the land only, and can make improvements to the land permitted by the lease. The lease is renewable in perpetuity with the rent reviewed on periodic renewal dates.

The leases in question provided that the reviewed rent was to be determined by a formula, under which valuations are required of first the gross or capital value of the land as improved, and second the value of the improvements of the lessee. The annual rent is then determined by applying a percentage (in this case 5%) to the net amount after deducting the second value from the first.

The intent of such provisions is that any increase in the value of the land over time benefits the lessor, while the lessee owns the improvements and so does not pay rent on them. Where land values have risen steeply over the lease term, this can result in dramatic increases in the ground rent, causing difficulties particularly for residential lessees.

Since the 19th century, valuers have debated the precise method by which the two values in this formula are reached. The 1918 case of Cox v Public Trustee resolved a number of the issues, but the debate has continued, including a 1948 Royal Commission report and 1993 Ministerial Inquiry, with lessees seeking to soften what can often appear to be a harsh result.

So what has changed for valuations of ground rentals?

The answer is: not much. The Supreme Court rejected the three arguments put up by the lessees and confirmed the valuation methods adopted in Cox.

Lessee's argument number 1: The valuation of the improvements should not be determined only by reference to the value that they add to the land as unimproved.

The lessees advocated using measures such as depreciated replacement cost to determine the value of improvements. This was to counter what they considered to be an incorrect approach whereby the value of the unimproved land is assessed first, and then the value of improvements calculated by subtracting the unimproved land value from the gross value (the so-called "subtraction" method). In the lessees' view this resulted in the value of the improvements being "squeezed".

Click here to view the calculation.

The Court agreed that using the unimproved value of the land in this way would not accord with the method required by the leases. However it did not agree that the depreciated replacement cost could be relied upon to determine the value of improvements in all cases.

Returning to basics, the Court held that the nature of "improvements" is that they have made the land better than it was - they have "improved" it. "An added-value approach is intrinsic to the concept of improvement. If work done does not add value then it is not an improvement. And attributing to improvements a value which exceeds that enhancement would result in the lessor not receiving a rent based on the value of the land". However the Court considered that there is a place for depreciated replacement cost to be used to assess the value of improvements, where there is limited or no direct market evidence in relation to unimproved land, and the land has been developed in accordance with its highest and best use.

The Court found that the valuer would necessarily attribute a value to the land as unimproved "at some stage in the process". Since the value of the improvements is necessarily the difference between the gross value and the land as unimproved "it is difficult to see why improvements should not where appropriate be valued by subtraction".

The Court emphasised the purpose of the exercise - to find the real value of the unimproved land. In doing this valuers should use the most accurate measures available and, if there is a limited market for unimproved land in the area, which is the case in the established urban areas where such leases are typically found, the best measure may be the depreciated replacement cost of the improvements.

Lessees' argument number 2: The gross value of the land and improvements should take into account the restriction in the lease to a single dwellinghouse.

Here the majority of the Court found against the lessees, because the proper interpretation of the rent review provisions in the lease did not leave room for such a restriction in the lease to be taken into account in the valuation. In essence, the "fact" and therefore the content of the lease is ignored when assessing the unimproved value of the land. Of course, non-lease influences, such as zoning restrictions, would be relevant.

However, Chief Justice Elias dissented on this point, considering that it would be inconsistent with the nature of rent reviews for valuers to ignore the development restrictions in the lease, as they affect the fee simple and so run with the land in the same way a covenant does.

Lessee's argument number 3: The land as unimproved should be valued on an "occupied site basis".

The Court held that the value of unimproved land should not reflect the existence of buildings on the site. The whole point is to give a return to the lessor on the underlying land value, excluding any value contributed by the lessee's improvements.