Certain long-leaseholders of flats have a statutory right to extend their leases. Where the statutory process is followed, on payment of a premium, the lease can be extended by an additional 90 years at a peppercorn ground rent.

A recent case has given some useful guidance on how that premium should be calculated. The Upper Tribunal held that a particular model used to calculate the premium, the ‘Parthenia model’, should not be used in future cases and the Court of Appeal agreed.

Explainer: how is the premium for extending a lease valued?

Part II Schedule 13 of the Leasehold Reform, Housing and Urban Development Act 1993 (the Act) states that the premium should consist of three components:

  1. the diminution in value of the landlord’s interest in the flat consequent on the grant of the new lease;
  2. the landlord’s share of the so-called ‘marriage value‘ (where applicable); and
  3. compensation for any other loss that the landlords will suffer as the result of the grant of the new lease.

The diminution in value is the difference between the value of the landlord’s interest in the flat before the grant of a new lease compared with the value of the landlord’s interest after the new lease is granted.

The marriage value is the difference between the aggregate of:

  1. the value of the interest of the tenant under the existing lease; the value of the landlord’s interest in the tenant’s flat prior to grant of new lease; and the values prior to the grant of that lease of all intermediate leasehold interests (if any); and
  2. the value of the interest of the tenant under the new lease; the value of the landlord’s interest in the tenant’s flat once the new lease is granted; and the values of all intermediate leasehold interests (if any) once that lease is granted.

Marriage value will be assessed where the current lease has an unexpired term of less than 80 years. The landlord’s share of the marriage value is fifty per cent.

The issue in dispute: calculating the ‘marriage value’

To determine the marriage value there has to be a calculation of certain elements, such as the value of the freehold with vacant possession. However, valuing the freehold for these purposes presents two difficulties, both of which are captured by the concept of ‘relativity’:

  • First, as sales of flats with vacant possession are almost always sales of leasehold interests, the leasehold values first need to be converted into the freehold value.
  • Second, the calculation requires a value to be obtained for the flat on the basis that it does not benefit from the rights conferred under the Act (referred to as the “no Act” assumption). Again, though, in the real world most sales of leasehold flats are sales of leases to which rights under the Act attach.

There are different methods to determine the relationship (or ‘relativity’) between the real-world value of the leasehold interest and the value of the interest for the purposes of the marriage calculation. The most common method is to use ‘relativity graphs’.

In Mundy v the Trustees of the Sloane Stanley Estate, the tenant, Mr Mundy, disagreed with the Landlord’s use of one commonly-used relativity graph, known as the Gerald Eve graph. Had the court found in his favour, there would be significant repercussions for a number of large estate holders that routinely rely on this relativity graph.

Upper Tribunal decision

The Upper Tribunal, at first instance, looked in detail at both the Gerald Eve graph and an alternative model which Mr Mundy sought to rely on, known as the ‘Parthenia model’.

The Upper Tribunal valued the leases and compared their valuation with the output from the Gerald Eve graph and Parthenia model. On one of the valuations, the Parthenia model reached an impossible result – that the value of the lease on the “no Act” assumption was higher than the real-world value with the benefit of those rights – and was therefore held to be inherently unreliable. The Upper Tribunal described the Parthenia model, colourfully, as “a clock which strikes 13”.

Mr Mundy appealed the Upper Tribunal’s decision.

Court of Appeal decision

The Court of Appeal, agreeing with the Upper Tribunal, rejected the appeal and held that the Gerald Eve graph was more reliable and preferred to the Parthenia model, which was not to be used in the future.

The Court of Appeal also rejected Mr Mundy’s argument that the marriage value calculation should have been made on the basis that the entire market was one in which no rights were conferred by the Act. The decision therefore clarified that the “no-Act” assumption, referred to above, applied to a “no-Act building” rather than a “no-Act world” (as had been suggested in some previous cases).

Take away points

Although the Court of Appeal criticised the Parthenia model, it found that by no means were the other methods (such as the Gerald Eve graph) perfect. The Upper Tribunal made its valuations on the basis of what it described as the “least unreliable” evidence and whilst the Gerald Eve graph is not perfect, it is based on real market transactions and therefore it cannot be ignored. The Court of Appeal commented that “the market may not be perfect but it is still the market”.

It is possible that the decision will put this issue firmly back on the Law Commission’s radar, along with the government’s request for the Law Commission to look into the simplification of valuations under the Act. As such, there may still be hope for the imposition of a more reliable method of valuing the marriage value, and in turn, the premium payable for a lease extension under the Act.

However, for now, landlords who have traditionally used one of the methods for determining relativity as considered by the Upper Tribunal, in particular the Gerald Eve graph, will take comfort from this decision.

This article was written with the assistance of Katrina Roe, Trainee Solicitor at Osborne Clarke.