How to Value Tenants’ Improvements for Leasehold Enfranchisement - Thomas Jefferies

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Our guest in today's podcast is Thomas Jefferies, an experienced property litigation barrister and an authority on the subject of leasehold enfranchisement.

When it comes to leasehold enfranchisement, not all of the changes done by tenants add to the property, most of them are just repairs. From a valuation point of view, to be legally categorised as an improvement, a change needs to make the property worth more. This can be seen as unfair on the tenants as they pay for all that work, but then have to pay the additional value in all evaluations.

On the topic of Do's and Don'ts, Thomas's advises all tenants to keep all the records of the improvements done during the lease.  For landlords, Thomas recommends an inspection every few years, looking for unauthorised alterations.

Interviewer - Farnaz Fazaipour | Property Investment & Ownership

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Transcript

Unknown Speaker  0:00  
London property homes super prime, where you can find informative educational and entertaining content, covering all aspects of property.

Farnaz Fazaipour  0:11  
Hello, and welcome to London property, the home of super prime. I'm your host Farnaz Fazaipour. And today we're in conversation with Tom Jefferies
, an authority on the subject of leasehold enfranchisement. Welcome to the show.

Unknown Speaker  0:23  
Thank you. Nice to be here.

Farnaz Fazaipour  0:25  
So Tom, tell us about yourself and what you do in this space.

Unknown Speaker  0:29  
Well, I'm a property litigation barrister. I've been practising for about 40 years now. And back in the 1990. So I found myself getting involved in leasehold enfranchisement. And I found it a really interesting topic. There's lots of law valuation, and you get to snoop around lots of lots of really interesting houses in nice areas, and meet lots of very interesting people. So it's snowballed, and I've done more and more cases. And now I'm one of the specialists in this in this area.

Farnaz Fazaipour  1:10  
Fantastic. Well, we're very pleased to be speaking to you today. And today, we're going to focus on tenant improvements. So should we start by you telling us what are tenant improvements when it comes to leasehold enfranchisement?

Unknown Speaker  1:23  
Well, people, people talk about home improvements, which covers just about everything you do to your house. But not everything you do is what's legally categorised as an improvement. So if you just redecorate your house, or you change the bathroom fittings, you don't like the avocado ones, and you change it to a different colour that's just repairs or replacing what's there. But if you do something that changes it significantly, like changing the layout, or installing a new bathroom or air conditioning, that counts as an improvement, it adds to the property from the point of view of the tenant. And from a valuation point of view, it makes the flat property worth more. So that's an improvement.

Farnaz Fazaipour  2:17  
And how does the tenant improvement affect the valuation process for in franchise?

Unknown Speaker  2:22  
Well, the starting point is the tenant has to pay the effectively by the value pay for the value of the landlord's interest in the property. The starting point is you value what you see you value the flat as it stands at the valuation date, which is when you serve your your notice. But that can be very unfair on the tenant, if I've spent a million pounds doing up my flat, putting in air conditioning, fancy new floors, state of the art, bathroom, and so on. That adds to the value. So it's seen as unfair on the tenant that he should not only pay for all that work, but then have to pay the additional value in all evaluations. Tenants improvements are disregarded. So you you have to value the flat as if the work had not been done. So you imagine it on the valuation date, as if it didn't have the change layer, it didn't have the air conditioning and so on.

Farnaz Fazaipour  3:30  
Because I imagined that leaving things to imagination must open up a whole host of other issues. Can you also ignore the scope for that work to be done?

Unknown Speaker  3:40  
Well, that that's a that's a question that came up in about 2005 in a case called for tile, all about a house in Hamilton terrace, one of the most litigated streets in London, I think, where there was a there was a house 19th century house, which started out at 3000 square feet, and the tenant built on top of it behind it. And it by the valuation date it was it was 9000 square feet with the benefit of planning permission for all that additional work. And everyone agreed you had to disregard that and value the 3000 square foot house that had been there before. But then the question was, well, what what can you assume about the scope to add to it? The tenant said well, you just have to value it as a 3000 square feet house. And the landlord said, no, no, no, you have to take account of the fact that planning permission was granted allowing all this extra work. And you have to add to you have to allow for the additional value of the scope to carry out that additional work. And the lands tribunal agreed with the landlord, and said, No, you don't disregard the planning permission. And you'd have to have regard for to the, to the value of adding all that extra floor space. So typically what you do is you take the finished value, the gross development value, and you deduct the cost of carrying out all the work and allow for profit and risks and things like that. So you end up with what's called the site value. And in that case, it was 25%. So yes, you disregard all the additional value created by the work, but you allow for the possibility of doing that work, which in that case, worked out about 25% of the, the actual value that was created.

Farnaz Fazaipour  5:53  
Okay, because you also have this in the Grosvenor centre, you would the air rights above properties. So I guess when you're going for freeholds, there, you have to account for that as well.

Unknown Speaker  6:03  
Well, I'm Grover Grosvenor, try and exclude the airspace, lots of people, let them get away with it. But you shouldn't, because they're not entitled to retain the airspace. But they do it because they want to hang on to the development value. And if you come along and you want to build an extra story, they'll want they'll want half half the the added the added value.

Farnaz Fazaipour  6:27  
Gosh. So on the subject, can you tell us about the Alberty case? And how is that relevant in this topic?

Unknown Speaker  6:36  
Well, yes, well, that followed on from the football case, that was that was a case earlier this year, about a house in Cheney walk owned by originally owned by Gerald Scarfe, the cartoonist, and he bought it as an old house converted into five flats. And he converted it back into a single house. And at the time, you didn't need planning permission for the work, the conversion work, he should have got planning permission for change of use back to a single house, but he didn't get it. After four years, you're immune from enforcement anyway, so it became a lawful what's called the established use of building roll forward to 2014 and Kensington, were getting alarmed at the loss of all the so many flats because it was in increasingly popular to turn flats back into houses and create big mansions for people, you're immensely valuable. So Kensington tightened up, so that you you need the planning permission to turn flats back into a house. And what's more, they had a policy of resisting planning permission if you're going to lose more than one flat. So for this house, that Carol scarf test it by after 2014 Everyone agreed, you would not get permission to turn it back into a house, even though in fact it was being used as a house. So then you get to the valuation. And of course, in fact, it was it was a house with permitted use as a house. It was common ground, you had to disregard the work. So you have to value it physically as five flats.

Farnaz Fazaipour  8:40  
But even though the time had elapsed, and it was

Unknown Speaker  8:44  
yes, because you have to disregard the physical work converting to a house. So you have to imagine there was a building comprising five, five flats, okay. But the question was what what assumption you can make about the potential use, because if he had, in fact, it had established use for planning as a house? Well, if it if it, if you valued it with that potential, then you can convert it back to a house. Whereas if you if you had to ignore that established us, then we know you wouldn't get planning permission, so you have to value it as flats, then it was worth at least 2 million pounds more. If you could turn it back into a house then then if you had to disregard the established use. So the question was whether you could you could ignore whether you could disrupt you should disregard that established use. And the landlord's arguments was, well look at that fertile case, they didn't disregard the planning permission. So it would be odd if you disregarded the They established us. And they said, all you have to disregard is the work nothing else. And there's no unfairness to the tenant, because he didn't pay for the established use. And he didn't pay for the fact that Kensington had changed his planning policies, that's just a quirk of quirk of history, it would be very unfair to the landlord if they lost all that uplift in value. But that argument didn't didn't work. And the tribunal said, when you have to disregard the work, and you have to disregard it, for all purposes, you have to assume it'd never happened. And so you have to disregard all the consequences of the work not having been done. So, if the work hadn't been done it, it remained as five flats, it would never have got established use as a as a house. So you also had to disregard the the established use, because that only came about because of the work that was done enabling it to be used as a as a house. So the tenant did very well in that case, and got got got got got the benefit of a greatly greatly reduced price. The landlord is trying to appeal to the Supreme Court. So what may or may not be the last the last word on that particular one?

Farnaz Fazaipour  11:43  
And what do you think the implications of this case are?

Unknown Speaker  11:46  
Well, that it's the case itself is quite unusual, that that that particular set of facts, but much more common scenario, which it has implications for is where you have a planning permission, say you've got planning permission, I did a case like this. Earlier this year, were planning from the permission of being granted back in the 90s, to build an extra story on on on top of on top of the flats, and they do Lee carried out the work. So there's common ground, you have disregard the work. But what about what about the planning permission? Well, you can't disregard the fact of the planning permission, because the planning permission was granted before the work was carried out. So it wasn't a result of the work. But and this is the normal case, planning permissions have to be implemented within within three years. And you can only implement them by carrying out development work, which is preferable to the planning permission. So if you didn't do the work building the extra story, you have to imagine you didn't do that work. You also have to mention, you haven't implemented the planning permission. So that planning permission, yes, it's there as part of the history, but it's spent. And in that case, as in many others planning policies have changed. And the planning evidence was in that case, you would not now get planning permission for for the same, the same work. So you disregard you in that case, you had disregard the scope for doing the work, as well as the fact that it had been done. So. So that's to that one implication. But then also, you have to start thinking about licences for alterations. Most of these cases, you need a landlord's licence for alterations. And if if it's a very simple one, you don't disregard it. So it might still be capable of being implemented. But in many cases, the licence says you have to complete the work within a certain period. So if you haven't done the work, and you haven't implemented the licence, does it lapse, that? Do you need fresh consent again from the landlord? So they you have another risk factor with the landlord actually get consent in this hypothetical, imaginary scenario we're talking about? So that depends on the terms of the licence in the particular case. But, but that's, you know that that's another interesting implication of the Alberty case. So broad terms, it's, it's going to help tenants, it's going To is going to reduce the price payable, where you've got significant alterations which which needed the planning permission.

Farnaz Fazaipour  15:12  
So if I'm understanding this correctly, in the case that you just referred to the planning permission was granted the works were done. But because you've got to disregard, you imagine that the works were not done, the planning permission wasn't granted. Whereas in the Hamilton terrace one, there was planning permission. The Works hadn't been done yet. But you're still paying for the benefit of the work to be done.

Unknown Speaker  15:37  
Now what what they said in fertile was, you don't disregard the the fact that the planning permission was granted. And in the case I talked about, likewise, you don't disregard the fact that planning permission was granted. But it like all planning permissions, it's subjected to a number of conditions, it has to be implemented, it has to be started within three years. And if you don't start it, it lapses. So it's no longer available. So that's what happened in my case. And that's what will happen. In most cases. If the work was done more than three years ago, the planning permission was more than three years old, chances are it won't be available anymore, even though you've done the work, even though you've done the work. So you imagine the work has been done. Yeah. And then, you know, there was a planning permission, say five years ago, but you will, you will assume that that planning permission has lapsed. So you will need a fresh planning permission. Now, in a simple case, you may it may be obvious you get planning permission in an uncontroversial case. But when planning policies have changed, then you may may well no longer get the planning permission. So you disregard the scope to do the work. If would no longer be available? Yeah, that's right. So so that that gets you an even bigger reduction.

Farnaz Fazaipour  17:07  
So it sounds like there's a lot of business to be done for pre planning applications here, for both sides. If somebody's going to say, you won't get it or you will get it than the other party can go. Within three weeks, try and get some certainty on whether it will happen or it won't happen.

Unknown Speaker  17:23  
Yeah, I mean, where you have arguments about whether you get planning wish, and it's you often you quite often get a planning expert, but the simplest way is to go approach the council and do a pre app, as you as you say, and see what the council says. But you tend only to do that if you're pretty confident what the answer is going to be. I mean, if you're a landlord, you will, and you're trying to emphasise, you would get planning permission, you go and get some pre app advice, if you're confident that you would get it. So you can say, because on the valuation, you have to imagine a hypothetical sale at the valuation date date of the notice. And you say, well, the imaginary purchaser would he'd be thinking, Oh, yes, I can build this extra story. I'm better check planning. I won't go and ask, do a prayer at the council. And then the landlord produces the actual prehab to show the tribunal and say, Well, this is the response he would have got. So he would be confident he could he could do the work. Kill us.

Farnaz Fazaipour  18:34  
It's no wonder you find it so fascinating. Because, you know, we think okay, if all the leases on all these bigger states are going down, what's next? But there's so much more to keep interpreting and exploring, isn't it in this in this?

Unknown Speaker  18:47  
Yeah. I mean, the the the the issues changed sort of every every couple of years. The issues change you had you had arguments about deferment, right? Then you had arguments about the value to stay at the end of a long lease. And in the last few years, I'd say over half of my work has been about development value. And even though these states have sold off most of their estates there, there's still a lot of cases about development value in particular, the ability to build on top of existing buildings. Because as you know, they are now permitted development rights to build on top. So quite often, the the tenants are worried that they're building qualify is they're worried the landlord might try and build extra flats. No tenants want that to happen. So they claim the Free Hold on make a collective infringement claim. And, and then you end up with an argument about development value The landlord says, Well, I've got potential to build an extra two, four flats on the top of this building. And that's worth an extra few 100,000 or million or, or whatever it might be. And the tenants will say, No, there's no such value because you wouldn't get planning. The building's not strong enough, and so on. I mean, I did a case about just that. Earlier this year, we've just got result out. So I've done I don't know, dozen of those sorts of cases now, both for landlords and tenants sites, that is a very common form of dispute that goes on now. Where you've got blocks of flats,

Farnaz Fazaipour  20:48  
and then the counter argument would be to actually see whether it's from an engineering perspective, it's actually possible, I suppose. So then you have to figure that out in order to argue with your landlord. Well, actually, the foundations were hold it.

Unknown Speaker  21:01  
Yes, exactly. Is that is the building strong enough? Yeah. You get where you get 1930s blocks of flats, they were often not not particularly sturdy, built. So sometimes, there's there's an issue about that, by and large, you can put a lightweight structural on top. But you can end up with a raft of experts, planning experts, engineering experts, quantity surveyors, valuers, it can cost a fortune to, to argue these cases, which is fine if there's a lot of money to be saved. But it can just eat up the the amount at stake.

Farnaz Fazaipour  21:46  
And we've had we've had the white paper and the recommendations and all of that that is pending some changes, too. Are you worried about any of those? Or do you think any of them are really good news, and they're going to open up another whole host of?

Unknown Speaker  22:03  
Well, there's bound to be even more litigation as and when the new legislation comes in, because it's going to be wholly, wholly new. And there'll be limitless new things to argue about, it'll be like 19, the 1990s all over all over again. It's got to be that big. Yeah, I mean, it's it's, it's a they're undertaking a huge task, trying to try and rewrite all all the legislation. So there are bound to be issues about what what the words they use mean.

Farnaz Fazaipour  22:40  
So as a barrister of leasehold enfranchisement, traditionally, you had to be instructed by a solicitor? And can you just talk to us about how that's changed and how our listeners could get your expertise?

Unknown Speaker  22:52  
Well, that's, that's changed, because they first of all, change the rule. So we could be instructed by professionals such as in this case, surveyors, a lot of my work comes from surveyors, who know me to introduce me to their clients. But then they changed it again. So now I can work directly with members of the of the public. And I'm very, very happy to do that. And with this sort of work, most of the people I deal with are very well well informed, smart, smart people who can give me the information I need, and I'm very happy to work with them directly.

Farnaz Fazaipour  23:40  
So it's a really good first step for people, as you say, who are already quite savvy in the subject, when they're trying to make a decision to just say, Okay, I'm just gonna pass this by you. What do you think should I go this way? Or that way? Yeah, a

Unknown Speaker  23:51  
few good a few good. A tricky, tricky issue. Yes. That's that's, that's right. Yeah.

Farnaz Fazaipour  23:57  
We've talked about how tenant improvements affect the valuation process. Can you tell us in your opinion, what are the do's and don'ts for a tenant to consider

Unknown Speaker  24:07  
the advice I would give a give tenants and if if your is first, first of all, make sure you keep records of any work you do, particularly if you do anything, anything substantial. Keep plans of the flat or the building before and after you do the work, keep keep photographs, keep invoices, because all this is important, because the burden is on the tenant to prove that, that the tenant has actually done all the work at their own expense than if you're buying a flat which has been which has been greatly improved, and you might want to extend the lease. Likewise, ask the vendor for records of the work they've carried out. Because you can get the benefit of the disregard of the work you're free. This test is carried out. So you want to be able to prove all that. Any if there's asked if there was a licence for alterations, ask for the plans, photos, invoices, all that sort of thing. Don't despair if none of that is available. And quite often, if you have all you have is like one I'm looking at recently you have a lease plan from 1989 showing one layout, you go look at it now, then it's got a bathroom in a different place. So normally, the tribunals happy just to infer that the tenant at the time being did did the work, because who else would do it? And why would they want to spend the money on it, but there can sometimes be room for for, for questioning that whether it was done before or after the lease was granted say. So that's why it's important to have all these all these records to be able to prove what was done.

Farnaz Fazaipour  26:12  
So since we live in a world of imagination, can you also say Well, hang on a minute, that was before 1993 You had no rights anyway? No, that's that's a step too far. No. Do you do is most of your work for tenants or is it tenants landlords?

Unknown Speaker  26:29  
It's it's it's a mixture.

Farnaz Fazaipour  26:32  
It's a mixture. So do you have any do's and don'ts for landlords?

Unknown Speaker  26:35  
Well, I I'd say to the landlord, do do go and inspect the property now and then so that you can see what's going on. Because you do quite often get cases of tenants carrying out unauthorised alterations that you may not be aware of it may be you could have charged for them. And if you don't discover them and the tenant claims the lease extension you may find you're not getting all the benefit you could have done have you been asked for consent to go and check every few years

Farnaz Fazaipour  27:16  
is because after four years comes check

Unknown Speaker  27:18  
the condition of the of the property. So you can take action if you if you if you need to if something unauthorised has been done.

Farnaz Fazaipour  27:27  
So Tom, thank you very much for talking to us and giving us a glimpse into a very interesting world of leasehold enfranchisement and for our listeners, you can head over to our experts directory to get in touch with Tom directly or if you're looking for any other experts to help you with your real estate needs then our need to know experts can be found in the directory.

Unknown Speaker  27:47  
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