Rights of Light - Apportionment of Compensation Based upon Valuation of Leasehold Interests

Introduction

When a property has acquired a right to light and a development of adjoining land would cause a loss of light sufficient to be considered an actionable nuisance then the owner of that right might seek compensation for the loss rather than seek an injunction. The owner of the right may be solely the freeholder or the property or may include lessees and sub lessees. Equally there may be a number of separate properties that are affected and whilst one of the traditional methodologies for assessing compensation based on the book value of the loss might not require apportionment, the other methodology based upon the principles set out in Wrotham Park, would require careful apportionment between the affected parties.

In some cases, the right to light will be reserved to the freeholder and in others it will be either implied or granted by way of the lease agreement. The actual terms of any lease may not become apparent until after negotiations have commenced and surveyors need to be cautious in offering any advice eon the appropriate apportionment until such time as the individual interests are determined. Initial advice to clients will always be on the basis of freeholder in possession since this encompasses the total compensation that would be payable. In addition, some lessees having an interest in only part of the freehold property might suffer a light injury whilst others might not.

It is also possible that the light reduction to a leasehold interest would not, of itself, be considered actionable but the loss of light would be assessed as parasitical for the purposes of assessing compensation to the freeholder.

It is important to recognise that, where there are multiple ‘owners’ of a property, any negotiations would have to be concluded with each owner separately and that success in this regard is not always guaranteed (ref case?). Additionally, negotiations are of necessity a commercial activity and settlements do not have to reflect actual value but nevertheless a commercial assessment will be the starting point for the negotiations.

Methodologies

Traditionally, rights of light surveyors have employed the use of Waldram diagrams to determine the area of a room that would lose adequate daylighting as a result of a proposed development and this area is then converted to an Equivalent First Zone which is then valued in terms of light rental value to determine the appropriate compensation. This however is only one method and it is quite common now to examine what part of the development would be lost if adequate daylighting is to remain and then to apply a percentage to the profit achievable on that part. This approach arises out of the decision in Re Wrotham Park and is best demonstrated by the decision in Tamares (Vincent Square) Ltd v Fairpoint Properties (Vincent Square) Ltd [2006] EWHC 3589 (Ch); [2007] 1 W.L.R. 2148; [2007] 2 P. & C.R. 3 ; [2006] 3 E.G.L.R. 87; [2006] 41 E.G. 226; (2006) 103(36) L.S.G. 35; (2006) 150 S.J.L.B. 1191; [2007] 1 P. & C.R. DG19 where the judge said “The following principles applied to the assessment of damages for loss of the ability to prevent an infringement of a right to light at the point just before any infringement took place: (i) the court had to attempt to find what would be a "fair" result of a hypothetical negotiation between the parties; (ii) the context, including the nature and seriousness of the breach, had to be kept in mind; (iii) the right to prevent a development (or part) gave the owner of the right a significant bargaining position; (iv) the owner of the right with such a bargaining position would normally be expected to receive some part of the likely profit from the development (or relevant part); (v) if there was no evidence of the likely size of the profit, the court could do its best by awarding a suitable multiple of the damages for loss of amenity; (vi) if there was evidence of the likely size of the profit, the court should normally award a sum that took into account a fair percentage of the profit; (vii) the size of the award should not in any event be so large that the development (or relevant part) would not have taken place had such a sum been payable; and (viii) after arriving at a figure which took into consideration all the above and any other relevant factors, the court needed to consider whether " the deal felt right".

Occasionally a surveyor or valuer will argue that there will be or has been no loss of rental income as the development has had or will have the effect of enhancing the locale and thus improving rental income. This argument was defeated in Eagle v. The Charing Cross Railway Company. (1866-67) L.R. 2 C.P. 638 and therefore the loss must be valued accordingly.

There is, however, no leading authority on the appropriate methodology for determining the correct apportionment between the various interests that might exist and, in fact, most settlements are a matter of negotiation between the parties. The purpose of this paper is to identify the various circumstances that might arise and to derive from best general valuation practice the appropriate methodology for assessing the apportionment of damages in each circumstance.

Basis of Valuation of Interests

Freeholder

The freeholder has the benefit of an income stream from the leaseholder. For a defined number of years into the future this stream will remain fixed until at a predetermined time there would be rent review or the property would revert to the freehold.

In theory, a rent review after obstruction of daylight might result in loss of income to the freeholder as would a reversion and remarketing of the property. Therefore, the freeholders entitlement to compensation would be calculated on the basis of reversion to perpetuity at the time of rent review or reversion.

Intermediate (or Investment) Leaseholder

An intermediate leaseholder holds the property for a limited number of years and by subletting gains an income on the property. The difference between what is paid to their landlord and what is received from their tenant is termed ‘a profit rent’. In fact, the profit rent could also be derived as a notional profit rent where the leaseholder occupies the property and they are not paying the market rent for the property.

Entitlement to compensation must take account of the actual or theoretical loss of profit rent. That is to say that if the property is sublet then any rent review would, in theory, produce a lower market rent than would have been the case before. Similarly, where the profit rent is notional, the leaseholder will suffer a notional reduction in profit rent.

There will be a difference in valuation approach between these two examples as in the former the loss of profit rent does not occur until the rent review.

Occupational Leaseholder

An occupational leaseholder is not assumed to derive a profit rent as each rent review would reflect the market rent. However, if the loss of light occurred near to the start of a lease period then the rent being charged may be greater than the market rent for a substantial part of the term of the lease.

Valuation of Compensation to Leasehold Properties

Traditionally, where compensation for loss of light is payable to tenants as well as to the freeholder then the sum payable will be deducted from the total compensation value based on freeholder in possession according, inter alia, to the interest in the land, held by the tenant. To assess the correct amount due, it is firstly necessary to assess the market value of each interest be it freehold or leasehold. This is represented by the discounted value of the predicted future benefits derived from the ownership of that interest.

Anstey J. (1981) wrote that “There may very well be more than one interest in the property. It is very easy to apportion the compensation according to the respective interests straight out of the tables. Suppose you have chosen to capitalise at 6% or 16.5 YP. (Suppose also that none of the leases reserve the right to light to the higher interests/) The occupier has four years left of his term, the head lessee seven and then the freeholder comes into the reversion. All three interest must be assessed at the same rate, since a finite sum must be equitably divided, and our three therefore get 21%, 12% and 67% respectively of the capital sum (or 3.5YP, 2YP and 11YP of the annual figure.”

He then went on to state that “The theory is that when the rent next falls to be reviewed, the lessee’s rent will take into account the poorer light, and so his share of the compensation should be limited to the period before the review. On the other hand, he will suffer for that period, getting premises less well-lit than he bargained for, and he is therefore entitled to his cut.”

To most rights of light surveyors the above summary will be less than clear and it is necessary to refer to Anstey’s later book, in 1992, entitled ‘rights of light and what to do with them’, in which he referred back to his booklet of 1981 and then went on to give another example which can be interpreted and summarised as follows:

Using the single rate table in Parry with no allowance for tax and choosing the percentage column appropriate to the YP used for capitalising the compensation on the basis of freeholder in possession,  read off the multipliers to be used according to the period up to the next rent review.

Taking as an example an agreed EFZ injury of 300 square foot and a light rental value of ￡5 to produce an annual figure of ￡1,500 pounds and an agreed YP of 18  or 5.5% yield produces a capital figure of roughly ￡27,000. With an occupying tenant with three years to go to the next rent review and a head lessee with 27 years left and no review then the argument is that at the review for any lessee the rent will be assessed in the light of prevailing circumstances and so each is only affected until the next review.

Looking down the 5.5% column to ‘three years’ we find a multiplier of 2.6979 which, when multiplied by ￡1500 pounds equals roughly ￡4,050 pounds and is the occupier share. Next, using the head lessees terminal date of 27 years and a multiplier of 13.8981 deduct the 2.6979 already paid to the tenant and then multiply it by ￡1,500 by 11.2 producing ￡16,800. Then ￡16,800 + ￡4,050 gives a total of ￡20,850. The difference between this and the full value i.e. ￡27,000 less ￡20,800 is the freeholder share amounting to ￡6,150. Using this approach with a little more accuracy, this can be represented in the following table.

*This figure results from deducting the YP for the occupying tenant (2.6979) from the YP for the Head Lessee (13.8981) in Parry.

Table 1 – Apportionment of compensation where each party has an interest in the whole property.

The table may then be used in similar fashion where the lessees occupy only part of a building and the EFZ losses may be less than the total EFZ for the building, for example, where the freeholder retains common parts and/ or other parts are under separate leases.

Table 2 – Apportionment of compensation where the occupying tenant has an interest in part only of the property and the head lessee has an interest in the whole.

Where there are multiple occupying tenancies of parts of the building then it is necessary to split the head lessees interest down for each against the appropriate EFZ for that part in order to define the correct YP(s).

It is also possible, at least theoretically, that the yields for each interest could be different and this methodology will adjust for this scenario.

The important thing to remember is that the whole valuation process, as set out in Anstey, is an invention of a few practitioners and, although it bears a resemblance to valuations as practiced by proper valuation surveyors, neither the EFZ approach nor the light rental value are actually recognised in such authorities as Modern Methods of Valuation or the RICS Red Book and, for example, recognises no difference between residential and commercial properties or discounted cash flow (DCF) methodologies. For more on this see French, N. (2008), "The valuation of leasehold property", Journal of Property Investment & Finance, Vol. 26 No. 5. https://doi.org/10.1108/jpif.2008.11226eab.001

It is arguable therefore that the use of the EFZ approach with its four zones (instead of the three used by valuers for commercial shops, for example) and ￡5 per square foot for light rental should be reconsidered and perhaps replaced although both provide a mathematically consistent approach. In fact, the original theory, in the late 1970’s, regarding the ￡5 per square foot light rental value was that this represented the difference in rental income that would result from a property that was less well daylit than a nearby comparable property. This being the case, it would no doubt be possible for valuers to arrive at a correct figure to reflect modern conditions.

As a separate issue, the case of Carr Saunders v Dick McNeill Associates established that loss of amenity should be considered and that compensation for this could be valued as an uplift on the basic value.  On this basis, the percentages to the right of the table would be applied to the uplifted value.

In the situation where compensation is negotiated on the basis of the principles established in Wrotham Park, whereby a percentage share of the profit is allocated then the apportionment between the various interests could, theoretically, be achieved using the same percentages as those resulting from the use of the above table.

Other Potential Scenarios

Since the courts appear, of late, to be favouring the use of profit share-based compensation, it is necessary to consider how this might be applied where multiple properties, in different ownerships are affected by a development.

The method based on Wrotham Park and used later in cases such as Tamares, requires the use of a cutback analyses to determine the useable floor area that would be lost to the development in order to remove the light injury. The issue where multiple properties are affected is that more than one property might benefit from the same or similar cutback.

In simple terms, if we take the example in image 1, a tower built amongst a terrace of houses would cause significant reduction in daylight to the property immediately opposite as demonstrated by the contour drawings for rooms 1 and 2 but would also cause losses in the rooms in properties either side. 

Image 1 proposed high-rise block in terrace showing significant loss of EFZ in rooms opposite

If one were to design a cutback solution that removes this impact as illustrated in image 2 then the benefit would be felt not just by the one property but those either side as well.

Image 2 cutback solution to eliminate loss to rooms opposite

On this basis the share of the profit relating to the cutback would have to be apportioned between the properties affected but how would this be calculated?

Having researched some examples where proposed development sites were surrounded by a mixture of commercial and residential properties, all of whom might benefit from sections of any potential cutback solution, it is possible to illustrate how an apportionment, by property, might be achieved.

Table 3 shows a situation where the EFZ calculation has shown actionable loss in 12 properties and this has been valued in the traditional way with a book value and then a value where a 2.5 times uplift has been applied. It should be noted however that negotiations can and do result in greater uplifts but for this scenario we have a potential compensation total of ￡737,382.

Table 3 Results of EFZ calculation with book valuation method

In Table 4 each property has been considered separately to determine the amount of useable floor space in the proposed development that would need to be cut back to avoid actionable loss of daylight to the individual property being considered. This cutback has then been converted to a percentage of the sum of all cutbacks (It is important to recognise that this total is not the same as the total cutback that would be needed i.e. the sum of cutbacks here is 42,192.40 square metres whereas the actual cutback that would be needed to remove all actionable losses would only be 12,938.10 square metres. This gives an indication of the overlap that is occurring when the cutback for one property benefits others.)

Using the Wrotham Park methodology and assuming a profit of ￡3,000,000 then the 33% portion would amount to ￡1,000,000. This sum is then apportioned between the properties according to individual cutback as a proportion of the whole.

Table 4 individual cutback calculations and valuation using Wrotham Park basis

It can be seen from this that the compensation values move toward those residential properties on the middle of the terrace and away from those on either side.

Table 5 then compares the EFZ loss with the actual loss in terms of floor area which, in simplistic terms, demonstrates how the losses to the larger properties consist of a large proportion of parasitical losses i.e. where the losses on their own would not be considered actionable. This table also highlights the fact that the losses to properties 5, 6 and 7 are in fact quite small and yet it is these properties that would require some of the greatest cutbacks in the proposed scheme.

Table 5 comparing EFZ loss with actual floor area loss

Table 6 compares the book value basis with Wrotham Park basis to illustrate how compensation would be redistributed according to the methodology used. The final column also illustrates what would, in effect’ represent the worst-case combination.

Table 6 comparing uplifted book value with Wrotham Park

Other examples have been tested in a similar manner and, subject to the expected variations due to the individuality of buildings, the principle finding is that compensation to the larger properties is generally reduced and, to key residential properties, is increased using the Wrotham Park method.

Where compensation is based on the worst-case example above then the valuation of any leasehold interests could be much more complex. Each negotiation with freeholder and leaseholder(s) will often be carried out independently and, in theory, one affected party might agree on the basis of book value and another on the basis of profit share with a confidentiality clause preventing disclosure to other parties. Most importantly, settlements in respect of a single property with multiple levels of ‘ownership’ will need to have been agreed simultaneously to protect the servient owner from actions such as that which occurred in Metropolitan Housing Trust Ltd v RMC FH Co Ltd [2017] EWHC 2609 (Ch)

Section 203

Damages assessed in accordance with section 203 of the Housing and Planning Act 2016 C.22 would appear to be more straightforward provided that prior negotiations have taken place on a commercial basis (see my articles on s203 and Eagle v Charing Cross).

Taxation of Compensation

It is not for surveyors to advise on matters such as taxation but it is useful to have some awareness of the changes which came about in November 2014 and when compensation might be considered to be a capital gain.  In particular to note that where an uplift has been applied for equitable loss then this may possibly come under the changes and the recipient should, for the time being, seek advice from a specialist tax adviser but theoretically each could be treated differently.

References

Anstey J. 1981, The valuation of Rights of Light, Property Valuation Handbook, CALUS

Anstey J. 1992, Rights of Light and What to do with Them, RICS Books

Carr Saunders v Dick McNeill Associates [1986] 2 All ER 888, [1986] 1 WLR 922

Metropolitan Housing Trust Ltd v RMC FH Co Ltd [2017] EWHC 2609 (Ch)

Tamares (Vincent Square) Ltd v Fairpoint Properties (Vincent Square) Ltd (2007) LTL 15/2/2007 : (2007) 1 WLR 2167 : (2007) 14 EG 106 : (2007) 7 EG 143 (CS) : Times, February 14, 2007

Wrotham Park Estate Co Ltd v Parkside Homes Ltd [1974] 1 WLR 798

French, N. (2008), "The valuation of leasehold property", Journal of Property Investment & Finance, Vol. 26 No. 5. https://doi.org/10.1108/jpif.2008.11226eab.001