Guide to Ground Rents

how to value a ground lease


What are freehold ground rents?

When a residential development is constructed or an existing building is converted into flats, the individual properties are sold leasehold and the developer retains the freehold. The freehold constitutes the parts of the development shared between properties. The properties are normally sold on long leases (99, 125 or 999 years).

The lease terms state the annual ground rent to be paid from leaseholder to freeholder and whether the freeholder is responsible for buildings insurance or maintenance.

On expiry of a lease, the freeholder has the right to take ownership of the property and the leaseholder must leave. This is called a reversionary right.

The term ground rent is a generic term representing the freehold title and associated rights and obligations.

Who buys and sells ground rents?

A developer may retain the freehold for some time after a project is completed. Later the developer may decide to realise it’s value to aid cashflow. The developer may also be motivated by offloading the administration involved in ground rents ownership (e.g. collection of monies, management and maintenance of building).

Buyers include private landlords and professional ground rent investors aiming to build portfolios of ground rents. Pooling ground rents within a fund enables more predictable income and efficient administration and management. Some funds are then divided into units and sold on to individual investors.

A large number of ground rent buyers are registered with Freehold Exchange. including many institutional investors. If you are thinking of selling ground rents, request a listing to ensure they are marketed to an extensive network of dedicated investors ensuring an optimal price.

Valuation Considerations

The primary source of value for freeholds with a long time to lease expiry (more than 80 years) is from income generation potential. Annual income includes the ground rent paid by each leaseholder and can include commission payable through arranging building maintenance and insurance.

Additionally some value may derive from any future development potential of land in the freehold title.

Also, since the freeholder can look forward to a substantial lump sum at the expiry of the lease additional value derives from the present value of this lump sum. This contribution can dominate the valuation for reversionary leases (those with less than 80 years to expiry).

The above takes no account of the leaseholders option to extend leases or participate in a collective purchase (enfranchisement) of the freehold prior to lease expiry. In practice, leaseholders have the legal right to initiate such action at any time. The premium paid by each leaseholder in these cases is derived in a way similar to that outlined above but also includes an element of marriage value for leases with less than 80 years remaining. These possibilities of lease extension / collective enfranchisement can enhance value to the freeholder.

In summary freehold ground rents are income generating assets potentially also returning substantial cashflows at uncertain times in the future.

What are the Legal Rights of Leaseholders?

Right of First Refusal (Landlord and Tenant Act 1987)

In most cases when a freehold title is sold it must first be offered to the leaseholders

via a section 5 notice.

If the title is to be sold at auction, the (section 5b) notice effectively gives the leaseholders the option to the buy the freehold at the sale price. It is not until the auction date that the sale price is determined and the leaseholders have a period after this to decide whether to take up the option. Acceptance of the Notice can negatively influence interest at auction and the sale price achieved .

When selling the title in the open market, the (section 5a) notice must state a price. If this price has been pre-agreed with a ground rent buyer then the sale can proceed at this price whether to the ground rent buyer or the leaseholders on accepting the notice. Large ground rent investors offer to take care of the administration involved in serving section 5 notices at time of pre-agreement.

Lease Extension

Since the Leasehold Reform Act 1993 a leaseholder has the legal right to apply at any time for a lease extension. The terms of the new lease and premium to be paid can be settled by agreement or otherwise will be referred to the Leasehold Valuation Tribunal (LVT). Where referred, the new lease will be granted with peppercorn ground rent and a term of 90 years plus the present unexpired term. The premium payable to the freeholder will be decided as the sum of:

  1. Present value of ground rents under the existing lease.
  2. Present value of the reversion at expiry of the existing lease.
  3. Marriage Value if the lease has less than 80 years remaining.

The leaseholder will usually also be liable for the freeholders professional (legal and valuation) costs.

Marriage Value

Marriage value applies in cases of collective enfranchisement and lease extension and applies only to reversionary leases (those with less than 80 years remaining).

For a collective enfranchisement, marriage value arises from the perceived difference between:

  1. The value of the unrestricted freehold with vacant possession, and
  2. The sum of the leasehold and freehold values subject to the existing lease.

A similar increase in total value is assumed to occur as a result of a lease extension.

In order to calculate marriage value, a relativity rate (e.g. 90%) is used to relate the value of a leasehold interest with a certain number of years remaining to the unrestricted freehold interest with vacant possession.

Generally the relativity rate will decrease from close to 100% to eventually 0% as the time to lease expiry decreases.

Click here for a graph of historic relativities.

  1. Present value of ground rents.
  2. Present value of the reversion at expiry of the lease.
  3. Marriage Value if the lease has less than 80 years remaining. Note the marriage value for collective enfranchisement may be slightly higher than the marriage value for a lease extension.

The leaseholders will usually also be liable for the freeholders professional (legal and valuation) costs. Unlike a lease extension, the freeholder may also be entitled to the value of land or property not demised under the leases.


Category: Credit

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