People may be overpaying for lease extensions

People may be overpaying for lease extensions

People may be overpaying for lease extensions

The FINANCIAL -- People may be paying too high a price to extend the leases on their homes according to new research from the LSE.

The research, forthcoming in The Economic Journal, suggests that current leasehold extension practices underestimate the value of many leasehold properties.

This is significant because the valuation of a lease extension uses a concept, known as ‘relativity’, which describes how the value of the flat or house falls as the lease term runs down. The lower the relativity, the more the leaseholder has to pay to extend the lease.

The researchers estimated how a property’s sale price varies with the remaining term on the lease by analysing data from 8000 sales of leasehold properties that took place between 1987 and 1992 in Belgravia, Chelsea and Mayfair.

These areas have some of the highest concentration of short leases in the UK and also, unusually, have historical property data available.

This data allowed the researchers to compare the value of a leasehold property with the value of an identical freehold property in a period that pre-dates the 1993 Leasehold Reform Act, which gave most leaseholders the right to extend their lease(2).

The researchers compared their estimates with leasehold tribunal decisions and found that current practices underestimate the value of leases when there are less than 70 years left.

James Wyatt, a chartered surveyor and one of the authors of the research, said: “Our findings mean that many leaseholders may be seriously overpaying for lease extensions. Our alternative, evidence-based calculations could result in savings in the order of thousands of pounds for most leaseholders, and much more for owners of some of the most expensive properties.”

The research has already been tested in number of tribunal proceedings surrounding leasehold extensions and enfranchisements, and is due to be considered as part of a test case being heard by the Court of Appeal in January. Success will mean leaseholders pay a fair amount based upon market evidence and failure will mean thousands knocked off the value of their property.

The findings also have broader implications, outside of the housing market, for policy issues which have long time scales such as pensions, climate change and big infrastructure projects. These types of policies are evaluated using ‘discount rates’ which decide how much weight to put on future costs and benefits, relative to those in the present. Until now there has been little direct evidence to say what these discount rates should look like in the far future.

Dr Ted Pinchbeck, a Fellow in Real Estate Economics and Finance at LSE and one of the authors of the research, said: “Prices of leaseholds of different lengths provide direct new evidence on how people discount the very far future. Our results support the use of a time-declining discount rate, which is used for policy evaluation here in the UK, but not everywhere in the world. This kind of discount rate implies that people are actually willing to pay more or take action now to improve things in the distant future.

“This evidence may help to inform governments that have to make difficult choices today about, for example, averting the long term consequences of climate change."