When you extend your lease, your ground rent is removed. Accordingly, any ground rent that you pay needs to be factored into the premium for a lease extension.
This is in addition to the ‘reversion’ payment for a lease extension, which is to purchase the extra 90 years, and marriage value if your lease is below 80 years.
Why?
The basic premise is quite straightforward: After a lease extension, your ground rent is reduced to a peppercorn (i.e. £0).
As a result, any future ground rent needs to be "bought out" during a lease extension. In short, you are compensating the freeholder for the loss of their valuable future income stream.
What does this mean for my lease extension?
While you are buying out all the future ground rent, you’ll be pleased to know this doesn’t mean you pay the full amount of ground rent in your lease upfront. After all, money today is worth more than money tomorrow. This is due to inflation, and the fact you can invest a pound today and it'll grow to be more in a year's time.
To account for the fact money is worth more now than in the future, we apply a capitalisation rate on the ground rent, also known as a ‘Discount Rate’. It works like an inverse interest rate: rather than add money, it takes it away.
For simplicity, imagine you have a 10 year lease, where you are required to pay £100 every year.
If money didn’t lose value over time, the calculation would be simple: £100 a year for 10 years means the total ground rent is worth £1000.
However, this doesn’t account for depreciation in the value of money over time. If money next year was worth 10% less than this year, the real value of next year’s ground rent would be £90. If money lost an additional 10% the following year, the real value would be £81.
Applying this 10% rate to each year, and then adding the ground rent for each year together, would result in the ground rent being worth about £650 in total. This is the real value of your ground rent today at a 10% discount rate.
What if my ground rent increases?
This also needs to be factored into the calculations, which makes it more complex. We will still calculate a ‘real’ value for the increase. If it increases in five years’ time, then we would apply the discount rate to when the increase applies.
The approach we use varies depending on whether we (a) know what the future ground rent will be, such as a doubling ground rent, or (b) if it rises by a future factor we cannot know. For instance, we cannot know what RPI or the capital value of the flat will be in five years time.
Is the Discount Rate fixed?
No, the rate is not fixed and one of the main points we negotiate.
The 10% example rate is an exceptionally high rate. The ‘status quo’ rate is 6%, which has been agreed by convention for years now, although we think it is too low.
Returning to our above example, if we assume the lease length is 10 years and ground rent remains £100, but we apply discount rate is 5%, the total value of the ground rent would be about £800.
A higher rate means a lower premium, so our job is to try and negotiate the highest rate we can!
We argue for a higher cap rate by using market evidence of freehold auction assets. The less money an investor pays for a ground rent auction asset and the income stream it provides, the higher the discount rate. In recent years, we have good evidence to show buyers are paying less for these assets. This means higher discount rates we can use to argue for a lower premium.
In one case, we successfully convinced a tribunal to adopt a discount rate of 8.32% for a doubling ground rent based on market evidence.
However, the freeholder will have their own arguments to attempt to undermine this approach. They could also provide their own evidence that shows a lower discount rate.
The discount rate we can negotiate also varies depending on what type of ground rent you have. If you have a high ground rent that doubles, we can argue for a higher rate. If you have a lower ground rent, or one that increases by RPI, freeholders could argue for a lower discount rate.
For instance, there is a tribunal decision that determined a cap rate of 3.35% for RPI increasing ground rents, and freeholders typically use this for RPI increasing ground rents – but that decision was from 2017 and we would argue that the market has changed since then.
Do the recent pieces of legislation affect the rate we can negotiate?
There are two pieces of legislation to consider: Leasehold and Freehold Reform Act 2024 and the Commonhold and Leasehold Reform Bill.
The 2024 Act has been passed as law. This Act intends to cap ground rents for the purpose of a lease extension at 0.1% of the property’s value. It also intends to prescribe a discount rate for lease extensions.
For any high ground rents, it is likely your lease extension premium will be capped on the ground rent element. For instance, if you’re currently paying £500, but your flat is worth £300,000, then for the purpose of a lease extension calculation the ground rent will be capped at £300.
However, while the Act has been passed as law, not all the provisions, including the valuation provisions, have come into effect. As of June 2026, there is limited progress on these provisions, and we now assume it’s likely to be next year before anything is implemented. We still do not know what discount rate the government intends to prescribe.
The second piece proposes to cap all existing ground rents at £250 for the next 40 years, and thereafter reduce it to a peppercorn. If your ground rent is above £250, or set to rise above £250, you could benefit from this. However, this is only a proposed bill, so the £250 cap may not come into effect. Current estimates are ‘Late 2028’ or later before it will be passed.
Nonetheless, there is an argument that the investor market is being affected by this second announcement – after all, why would investor want to buy an income stream knowing it could be capped in the future. We have some early data to back this argument, which supports the use of a very high cap rate, possibly double digits.
So far, freeholder’s have resolutely rejected our argument. It will likely need a tribunal determination before freeholders are prepared to make concessions on this argument.
What's next?
Despite the upcoming changes, the basic premise of the ground rent calculation remains the same: during a lease extension we apply a rate to your remaining ground rent in order to pay off the freeholder for the loss of their income.
The higher your ground rent, and the more it rises in the future - the greater the bill for "buying out" your ground rent is likely to be.
As a firm we will keep monitoring legislative developments and evidence to ensure our clients are paying a fair price to buy out this income.
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