If you own a flat with a short lease, whatever it is worth now it will jump up in value if you ever extend the lease. On paper at least, you should make a profit.
If your lease has fewer than 80 years remaining at the point you extend it, you must share half of that hypothetical profit with your freeholder. This is known as “Marriage Value.”
My view (keep reading!) is that Marriage Value is deeply unfair to leaseholders. I want to believe Michael Gove agrees with me, which is why he is so keen to abolish it with the Leasehold and Freehold Reform Bill.
Yet, a more sceptical part of me thinks he is walking a careful line. A line which on one side has five million+ leaseholders holding ballot papers. On the other are freeholders who Gove thinks can be convinced that reform under Conservatives might be less damaging to them than the more radical promises of leasehold abolition by Labour.
What is marriage value?
To understand marriage value, you first need a grounding in how lease extensions are calculated.
All lease extensions (even when above 80 years) require a payment to the freeholder, and this has two components.
The first component is to buy the extra years.
Imagine you have a £200,000 flat with 80 years left on the lease, but you want to extend it. You need to compensate your freeholder for the fact they won’t get the flat back in 80 years’ time.
If you deposit £4,000 in the bank at 5% it will grow over time. Leave it there for 80 years and it will be worth about £200,000. For this reason, it is considered that a payment of £4,000 now is the equivalent to £200,000 in 80 years. £4,000 is what you’d need to pay your freeholder for the additional 90 years you’re currently entitled to.
Since a Court of Appeal decision known as Sportelli in 2007 this 5% “Deferment Rate” has been used in most lease extension calculations. I’ll come back to this later.
The second part of the payment is to “buy out” your ground rent.
Under current legislation you won’t pay any ground rent once you’ve extended your lease. A payment is required to compensate your freeholder for the fact they won’t receive your annual ground rent cheque.
Like above, each of the future payments is discounted: money now is worth more than money in the future. This time the rate is called the “Capitalisation Rate.”
Getting to the point, if your lease is below 80 years your lease extension premium will include a third payment – Marriage Value.
The cost of the payments for the extra years and the ground rent should be more than offset by the increase in value of the flat when you extend the lease.
That hypothetical profit is known as Marriage Value. It is called that because it is created when you “marry” the existing lease term with the additional 90 years.
Why is marriage value unfair?
Agree with them or not, the payments for buying the extra years and removing the ground rent explained above will compensate your freeholder for their loss of your future ground rent and your flat back at the end of your existing lease.
But Marriage Value isn’t about paying your freeholder compensation for their loss, it’s about allowing them to share in the hypothetical profit that you have made.
There are three reasons why it is not fair:
Reason 1: It doesn’t take into account the fact the leaseholder has to pay everyone’s fees
The profit doesn’t consider the fact that the leaseholder must pay their own fees but also those of their freeholder.
Imagine you do a lease extension and it’s agreed that the profit you will make when you extend your lease (after paying for term and reversion) is £8,000. You need to give half of this to your freeholder.
But Marriage Value doesn’t account for the fact that you need to pay all of the fees related to the transaction. It’s likely that your fees will be around £3,000, plus another the same again for your freeholder’s – so £6,000 in total. Your freeholder has pocketed their share of the Marriage Value, but suddenly your hypothetical profit turns into a hypothetical loss.
Reason 2: The “profit” is just returning money the leaseholder has already lost.
I had a client who bought a flat 1999 with a brand new 99-year lease. At that time a 99-year lease was long, and she paid as much for it as she would have done with a 999 one.
20 years later, with 79 years left on the lease she needed to extend the lease. She paid a large sum of marriage value for the profit she was hypothetically making.
But had there been a steady housing market (it’s irrelevant that it was not) she would have made a loss each year as her lease got shorter and shorter.
The freeholder wasn’t making annual payments to share that loss, so why should they share in the profit?
Reason 3: The freeholder’s share of the profit just gets bigger!
Funnily enough, the first thing someone does when they see a flat for sale with a short lease is ask how much a lease extension will cost. They will look at one of the many lease extension calculators, or call someone like me.
When they work out how much they want to pay for the property, they factor in the anticipated cost of the lease extension, the cost of the fees and more on top for contingency and for the hassle.
Marriage Value is based on the difference in value between flats with short leases and those with long. Therefore, unwittingly a transaction has been created which can be used to evidence an even higher lease extension premium both for that flat and for others in the surrounding area.
Over the last 30 years it has got proportionally more expensive to extend leases on flats with short leases, and it is this odd circularity between lease extension costs and the value flats which has done it.
How will the freehold community fight back?
Even though Marriage Value is clearly unfair, it won’t stop the community of freehold owners being up in arms that the gravy train has reached the station. They must have missed the memo that “The value of your investments can go up as well as down.”
They will be lobbying hard to try and minimise the impact on the value of their assets. This is likely to include a pincer-movement of the two approaches below:
Loudly through litigation
First, there is a genuine concern that freeholders will try and sue the government on the basis that their human rights have been infringed by the removal of marriage value.
The crux of the argument is that the “market value” of their assets includes marriage value. If a leaseholder didn’t have a legal right to extend their lease, they would be prepared to share in any profit they’d make by doing so to incentivise the freeholder to offer the extension.
The Law Commission were sufficiently concerned about this when they completed their consultation work in 2019 that they asked Catherine Callaghan QC to provide her opinion on it.
She stated that she thought it could be argued either way: “although the leaseholder under this scenario will gain the enhanced value from marrying the freehold and leasehold interests, arguably, the landlord loses nothing”.
She concluded by saying that there was broadly a 50/50 chance of a successful legal challenge.
Quietly and behind closed doors
There has been much hilarity recently because the headline benefit of the new legislation was that it banned leasehold houses – but the draft bill somehow forgot to do this!
This furore hid a potentially more sinister omission from the bill, which is that the Deferment Rate and Capitalisation Rate were not set either.
The government have consistently promised to make it “cheaper” for leaseholders to extend their leases, but if the Deferment Rate or Capitalisation Rates were reduced this would have the opposite effect.
Returning to the example above, the cost of purchasing the extra 90 years on a £200,000 flat with 80 years remaining and a Deferment Rate of 5% is about £4,000. Reduce the Deferment Rate to 4% and that goes up to £8,500.
If freeholders successfully lobby for a lower Deferment Rate to help offset the loss of Marriage Value, an unintended consequence is that it will increase the price that people with longer leases pay for their lease extensions.
So, the question remains, who does set the Deferment Rate?
Michael Gove of course! But not through Primary Legislation that will be scrutinised in the House of Commons and House of Lords. Instead, it’ll be set as Secondary Legislation, behind closed doors and possibly once the bill is passed.
In conclusion, it’s clear that we need to call time on Marriage Value and any efforts to lobby against its removal need to be firmly quashed.
But more importantly than that, we need to ensure that the other important elements of the calculation, including the Deferment Rate and the Capitalisation Rate are discussed at the same time as the primary legislation and kept and levels which are no lower than the existing rates.
This article has been written by Linz Darlington, managing director of Homehold which offer an end-to-end lease extension service with integrated lease extension solicitors.
