Mykonos Property Limited v Bird
[2017] NZHC 173
•16 February 2017
IN THE HIGH COURT OF NEW ZEALAND AUCKLAND REGISTRY
CIV-2015-404-3042 [2016] NZHC 173
BETWEEN MYKONOS PROPERTY TRUST
LIMITED Plaintiff
AND
CHRISTOPHER HALTON BIRD Defendant
Hearing: 15 February, 22 February, 23 March, 20 April, 22 April and 21
September 2016 and 9 February 2017
Counsel:
D J Chisholm QC and M Lenihan for Plaintiff
C H Bird in PersonJudgment:
16 February 2017
JUDGMENT OF FOGARTY J
This judgment was delivered by Justice Fogarty on
16 February 2017 at 3.30 p.m., pursuant to r 11.5 of the High Court Rules
Registrar/Deputy Registrar
Date:
Solicitors:
Brown Partners, Auckland
MYKONOS PROPERTY TRUST LIMITED v BIRD [2016] NZHC 173 [16 February 2017]
Introduction
[1] Mykonos Property Trust Limited (Mykonos) and Christopher Halton Bird (Mr Bird) are parties to a ground lease of a residential section in South Auckland, within the Lynfield Residential Estate on the southern shores of the Auckland isthmus. The lease is a perpetual lease, renewable terms of 21 years, with rent reviews every 7 years.1 The lessee, Mr Bird, does not agree with the uplift of the rent sought by the lessor for the next seven years. The lessor, Mykonos, has commenced proceedings for an order for possession of the land and cancellation of the lease.
[2] Mr Bird has failed to obtain legal aid and has been ineffectual in defending the application. He faced two “unless” orders before appearing in the High Court before me on 22 April 2016. Since that time I have been actively pursuing some potential deficiencies in the application for formal proof, without any assistance from Mr Bird, until today, which is no criticism of him as the point is sophisticated.
[3] As the judgment will go on to explain, supplementary evidence has been filed and the case was set down for hearing on 21 September 2016. Mr Bird did not appear. He was called twice. There are affidavits proving he has been personally served the latest evidence (of experts). I elected to continue for two reasons. First, there is no doubt in my mind that he had ample notice of the hearing. Secondly, he was unable to contribute, in any event. Rather, he was reliant on this Court requiring the lessor to prove for its remedy in accordance with the law.
[4] Mr Bird has refused to pay the new rental and has not taken advantage of the entitlement under the lease to arbitrate the new rental. I do not use the phrase “not take advantage” in any ultimately critical sense. It is more probable than not that Mr Bird simply does not have the financial resources to engage in the dispute resolution process provided by the lease. To be effective, he would have to retain a
valuer and a solicitor.
1 Also known as a Glasgow lease.
[5] Given the position of Mr Bird, I have scrutinised critically the application for formal proof and, along the way, issued various minutes calling for further information. As a result of this process, the point potentially advantageous to Mr Bird, and disadvantageous to the lessor, is the ground rental assessment rate being 5.75 per cent of the assessed land value of $525,000. This produces a ground rent of $30,187.50 (plus GST if applicable). Assuming GST is not applicable, that produces a weekly rental of $580.53, this being for a very modest home in South Auckland; described by the valuer for the lessor, Mr Davies, as “a smaller 1969’s bungalow”. The rating valuation of the house is $90,000.
[6] The rate setting is in the context of the rapid rise in land values in Auckland. At the time of the lessor’s valuation, on 18 November 2013, Mr Davies recorded inter alia, “sales activity for freehold residential property in the Lynfield Estate has seen a substantial rise in value, especially underlying residential land values over the last 12 to 18 months”. He noted that most properties were selling well in excess of the rating valuations assessed back in July 2011 and most properties have been sold under competitive sales programmes either by way of auction or tender. There was (and is) a shortage of listings and the current low interest rate regime for residential mortgage finance has had a major impact on the market. The statutory rating valuation of the land value on 1 July 2011 was $310,000, with a value of improvements at $90,000, as noted, a total of $400,000. Of course, not a great deal of weight should be put on the statutory valuation but indicatively, a little over two years later, the valuer places the assessed land value at $525,000. Upon my reading of the valuation of Mr Davies, I had no difficulty with his value of $525,000 for the land. He focussed correctly on vacant land sales data.
[7] If there is any weak point in Mr Davies’ analysis it is his derivation of the
ground rental. When he turned to the ground rental assessment he reasoned:
Taking into consideration the lease documentation we provide the following ground rental assessment as at 2 March 2014:
Assessed land value $525,000 @ 5.75%
[8] Mr Davies did not review interest rating settings in comparable properties.
[9] At the request of the Court, affidavits from two further experts were filed by the applicant landowner. These were by Mr Steven Dunlop and Mr Patrick Ryan. Both experts built up interest rate tables, collecting data from other leased properties in the area.
[10] These tables support a rental factor ranging between 5.75 per cent and 6.50 per cent, in the case of Mr Dunlop, and with a bottom range of 5.50 per cent, in the case of Mr Ryan. There is no doubt that these ground rental rates are being agreed in Auckland. In that sense, they are relied upon by the valuers as indicating the range of a fair rent.
Ground Rental Assessment – Traditional Approach and the Classic Approach
[11] The question then becomes whether or not the adoption of 5.75 per cent of the ground rental by relying on other rent reviews has been adequately justified in this case.
[12] There are two available methods of assessing the rate of return on the value of the land. These approaches are known to valuers as the “classical approach” and the “traditional approach”. The classical approach identifies market value of property by looking at comparable transactions, freely entered into by all the parties to the transaction. “Freely” means that the parties are willing, but not anxious to either buy or sell land. They are not locked in.
[13] The classical approach is not normally applied to the rate setting of Glasgow leases of this sort.2 This is because the dwelling on the property is in economic terms a “sunk cost”, so that the lessee is locked in. Under the terms of the lease, absent negotiation, and sometimes out of practicality, there is no viable way of taking the house on the property away to another section, and often, as here, the term of the lease prevents that step. The reality, therefore, is that the tenant is never a
“willing but not anxious” negotiator, because the tenant usually has no option but to
reach an agreement. For this reason the valuers use the traditional approach.
2 See above n 1.
[14] Mr Davies applied the traditional approach. He had reliable vacant section sales evidence. This enabled him to establish the capital value of the land at
$525,000.
[15] He then, imputed a fair rate of return, at the rate of 5.75 per cent and, as already noted, this judgment was assessed by two experts who built up schedules of rental rates in comparable properties and in the end supported Mr Davies’ selection of 5.75 per cent.
[16] The supporting argument in this Court was that the accepted hierarchy of rental factor evidence places the most weight on new lettings as the best evidence followed by negotiated settlements of rental renewals and reviews and then arbitrated agreements.
[17] The frequency of rental review is a matter bearing on the appropriate rental factor. Prevailing trends in and around the date of valuation indicate that the 21-year review/renewal cycle rentals are at around 6.5 per cent and the 5 to 7 year review frequency levels are at around 5.75 per cent per annum. This may vary slightly with individual properties but is a fairly consistent rule of thumb. The evidence tabled above illustrates this trend well.
[18] Messrs Dunlop and Ryan found a new letting in June 2014, to an incoming lessee, i.e. no sunk cost issue, of a 99-year terminating lease at 2 Sheridan Lane at
5.75 per cent.
[19] Based on this evidence and the terms within the subject lease, the 5.75 rental factor arrived at by Mr Davies is in line with comparable rental factor assessments around the time and is in the view of Messrs Dunlop and Ryan a fair assessment. I accept their review and their proper reliance on 2 Sheridan Lane.
[20] At the heart of my concern, however, was the ability of this lessee to pay an annual rental of the land of about $30,000, in addition to rates and insurance. That is Mr Bird’s complaint; he says he cannot afford it. The reason why I have pursued the question is that it appeared to me quite likely that the market rent for this section and
the small bungalow in South Auckland on a rate per week, was likely not to be much above $580 per week. It seems odd, if that were the case, that the ground rental should approximate the market rental of the whole property.
[21] In one of the minutes of this Court, and before the supporting experts’ affidavits were filed, I invited the solicitors for the plaintiffs to ask the experts to compare the assessed ground rental with the market rental for the whole property. The applicant-owner has expressly refused to engage the experts to do that on the grounds that the lease requires the assessment of ground rental to be completed without regard to the improvements on the property.
[22] Clause 16.1 of the lease provides:
The lessor shall review the annual rental every seven years from the Commencement Date (“Rent Review Date”) and the rental on any Rent Review Date shall be ascertained in accordance with the provisions of the First Schedule to the Public Bodies Leases Act 1969. In making the valuations provided for by clauses 2 and 3 of the said Schedule, no account shall be taken of the value of any improvements now or hereafter erected or made on the said land.
(Emphasis added.)
[23] The question remains, however, as to whether a rate of 5.75 per cent is fair for this lease. Clause 16.1 follows the Statute.
[24] The same Act in s 22, subs (2) provides for the rent to be “fair”:
fair annual rent of the land
The First Schedule repeats this concept of “fair annual rent” in cl 2, a clause otherwise devoted to setting a timetable for the lessor to provide the valuation. Clause 3 of the First Schedule provides:
In making the said valuation, no account shall be taken of the value of the following improvements on the land:
Specifying, as the lessor thinks fit, the kinds of improvements, whether made during the term or any other time which are not to be taken into account in the valuation of the rent.
(Emphasis added.)
[25] In the case of Granadilla Ltd v Berben the Court of Appeal had occasion to examine the test of a “fair annual ground rent” and to compare that with the traditional approach.3 The judgment of the Court was delivered by Blanchard J. Relevantly, he said:
Application of prudent lessee test
[5] It is long established in New Zealand that a valuer determining a fair annual ground rent must ascertain “what a prudent lessee would give for the ground-rent of the land for the term, and on the conditions as to renewal and other terms, etc, mentioned in the lease” (The Drapery & General Importing Co of NZ Limited v The Mayor, etc, of Wellington (1912) 31 NZLR 598,605). That test was most recently confirmed in this Court in Sextant Holdings Limited v New Zealand Railways Corporation (1993) 2 NZ ConvC 191,556 in which Richardson J (as he then was) and McKay J saw no difference between a prudent lessee test and one which posited a willing but not anxious lessor and a willing but not anxious lessee. We would add that for every abstract prudent lessee there obviously must be an abstract willing but not anxious lessor who has the premises on offer and must be assumed to be willing to “take a ground rent which a reasonable but prudent lessee thinks proper to give” (In re A Lease, Wellington City Corporation to Wilson [1936] NZLR s110 at s113)
[6] Importantly, the question is not so much what rental would give the lessor proper interest upon the value of the land but, rather, what rental would a prudent lessee give for the land for the term and subject to the conditions of the lease (Ziman v Auckland Grammar School Board [1929] GLR 208). In the application of this test or standard the rent is to be determined on the basis of the open market – a rent which is fair for the premises. What would the hypothetical prudent lessee pay for these particular premises available for the term for which they are available to the actual lessee and on the lease terms and conditions (other than rent) which are to be applicable to the actual lease? In the present case we are not concerned with any modification to the test such as is sometimes required by a particular rent review provision.
[7] Accordingly, the valuer is to be concerned only with matters which would affect the mind and ultimately the judgment of the prudent lessee in making an offer of rental to the lessor. It is the motives which would inspire such a hypothetical person, willing but not anxious, which are relevant. They include of course a consideration of the use to which the lessee may put the premises consistently with any restriction in the lease or the District Plan. Looking at the matter from the hypothetical willing but not anxious lessor’s perspective, it is what that party can reasonably expect to be offered which must be assessed, not what that party would like to receive (Wellington City v National Bank of New Zealand Properties Limited [1970] NZLR 660). In the Wellington City case Turner J, in this Court (at p.670) commented helpfully, if somewhat apologetically, upon the economics of rent fixing in the open market. He observed that the amount which tenants are willing to pay, not the return to lessors on their investment, is the factor which,
3 Granadilla Ltd v Berben CA191/98, 10 March 1999.
economically speaking, determines rental. “The level of rent is fixed, according to economists, purely by the margin of advantage which the given land enjoys over marginal land”. Even when no other comparable property is available, Turner J said, so that “rent may be regarded as similar to the price of a monopoly….it is demand which ultimately exclusively determines the price level.” Whilst accepting the validity of this position, it is necessary to add the qualification that in practice evidence of comparable rental arrangements may not be available or those ground rent which can be found may themselves have been set by a different method. In the absence of such evidence the valuer necessarily has to proceed by an approach which determines from comparable recent transactions a market value for the property and applies to it a percentage appropriate to the circumstances to arrive at a figure for the rental to be paid. A perusal of relevant decisions suggests that because relatively few new long-term ground rent leases are established, this approach may have become the predominant method of fixing ground rents on renewals of perpetual leases. The umpire called it the traditional approach.
…
[14] It is important, we think, to see the umpire’s resort to a return upon the value of the land in the context of the evidence before him and of the award as a whole. A valuer should preferably begin by considering comparable lettings, making adjustments for differences in time, physical factors (like location, size and dimensions) and lease terms, including duration. This is what was called by the umpire the classic approach. But if, as frequently happens, in a specific case the valuer reaches the conclusion that there are no, or no adequate, comparable lettings he must perforce adopt another approach which accords with settled valuation practice. As we have indicated, the traditional approach is such a settled practice. It was adopted for example, in Wellington City v National Bank where nearly all the comparable leases had expired at the same time.
…
[17] We agree with the Judge that, looking at the whole of the award, the umpire cannot fairly be said to have neglected the position of the lessor. We repeat that the fair rent is what the lessor can reasonably expect to be offered, not what the lessor would like to receive. There is more than just a hint of the latter, and a generous application of hindsight as well, in the appellant’s position. As Mr Corry pointed out, in arriving at his conclusions the umpire listed some 13 circumstances which he believed a prudent lessee would have borne in mind. A good number of these looked at the situation substantially from the viewpoint of the lessor (for example, the likely impact of the Museum opening which was, in April 1996, very nearly two years in the future). The award included a 15% upwards adjustment of the land value for the potential effect of that and other projects.
(Emphasis added.)
[26] I think the passages that I have cited support the proposition that the valuer should be asking ultimately, in this case, whether a prudent lessee would offer a
rental at the rate of 5.75 per cent, notwithstanding the extraordinary escalation in the capital value of the land.
[27] A rate around 5 per cent per annum is common. The President of the Court of Appeal, Cooke P in Hawke’s Bay Regional Council v Plested commented:4
Prima facie the answer is straightforward. What is required is “the fair annual ground rent of the said land hereby demised not taking into account the improvements as defined in Clause 32 hereof …”. The process of ascertaining the land value and applying thereto a percentage such as five per cent is common, although not obligatory in law (see Wellington City v National Bank of New Zealand Properties Ltd [1970] NZLR 660) and has been followed by the valuers in this case. In principle it should make no difference for the purpose of the argument if some other process were followed, for it is still the fair annual ground rent of the land hereby demised that has to be ascertained.
[28] In the case of Mandic v Cornwall Park Trust Board (Inc) the Supreme Court had the occasion to examine the renewal of the Cornwall Park Trust Board 21-year leases.5 It should be noted at the outset, and not forgotten, that the terms of the Cornwall Park leases provide for a 5 per cent return on land value. The lessees had applied to the High Court for declarations that the effect of the lease was to arrive at a residual value for the land, either as actually occupied by existing improvements
on the land, or on the basis of its use as a single dwelling, rather than according to its highest and best use.6
[29] The majority judgment in Mandic was delivered by William Young J. The rent setting in the Cornwall Park leases was complicated by a specific term, cl 13, which required two separate valuations to be made. One with the gross value of the fee simple of the land and the second of all substantial improvements of a permanent character made or required by the lessee and still in place on the land.7 The question was the valuation of the improvements. As, normally, the value of fixed improvements to land is quite a different number from the cost of construction of the
improvements, whether depreciated or not. As William Young J put it:8
4 Hawke’s Bay Regional Council v Plested [1994] 2 NZLR 1 at 4.
5 Mandic v Cornwall Park Trust Board (Inc) [2011] NZSC 135, [2012] 2 NZLR 194.
6 See [2].
7 See [28].
8 At [65].
Logically they have no value beyond the extent to which they enhance what would have been the value of the land if they were not there.
[30] Therefore it becomes problematic to identify a value for the improvements –
to deduct from the total value, or to derive land value, excluding the improvements.
[31] Mandic therefore has nothing to do with the particular issue in this case of the rate of return because of the difference in the terms of the Cornwall Part Trust leases. But it is authority for judicial insistence on following the rent formula in the subject lease, in that case the classic approach.9
[32] Accordingly, the best guides to the correct application of this subject lease are the dicta of the Court of Appeal in the judgment of Blanchard J in Granadilla and the judgment of William Young J in Mandic.
[33] The problem in this case is marrying the injunction in the lease and in the Public Bodies Leases Act 1969 against taking into account in any way the improvements on the land, (see [21] and [22] above) ,with the interpretation of “fair annual rent” as meaning a sum which a prudent lessee would “offer” to pay.
[34] If the land value warrants it, a prudent lessee might offer to pay a ground rent equivalent in fact to the rental value for the property with the old house on it in its present condition. This Court does not have the benefit of any experts called by Mr Bird, the lessee.
[35] It was reasonable, however, for the experts, Messrs Davies, Dunlop and Ryan, not to engage on this question, given the injunction of the statute to disregard the improvements and the legitimacy of the traditional approach by the Court of Appeal in Granadilla.
[36] At the time the rent came for review and the analysis was undertaken by Mr Davies, only one house could be erected on the section. Now it is two. I am satisfied that a rate of return of 5.75 per cent on the capital value with the small
cottage on the land with a rating valuation of $90,000, is on the probabilities an
9 See [62].
uneconomic rental, with one house on the section. Mr Bird said it would be more reasonable to walk away from the property and rent a three bedroom house rather than pay this assessed rental. On the particular facts of this case I agree. But his personal predicament, in part directly reflected by the limited nature of his house on the property, cannot and does not justify any different test for assessing the rental than that contained in the lease.
[37] Mr Bird has not displaced the option of a lessor taking over that section, and erecting a far more substantial property which justifies paying the higher rate of return.
[38] That is a maybe. It is also a maybe that the consequence of the rising values of land in Auckland has rendered this lease uneconomic from the point of view of a lessee. Again, that does not give this Court the jurisdiction to change the terms of the lease.
[39] Messrs Ryan and Dunlop made available to the Court a redacted version of a recent ground rent arbitration presided over by two retired Judges, Sir Rodney Hansen QC and the Honourable Mr Robert Fisher QC.
[40] Reliance is placed by Mr Ryan, supported by Mr Dunlop, on the Hansen/Fisher arbitration. That involves a reasonably large parcel of land of several thousand square metres in the Wynyard Quarter and apparently without a building on it. It also has the advantage in terms of comparable rentals that that area has been progressively developed in recent times so that there is evidence of bare ground rental value.
[41] It would appear there was a comparable block, relevant to ascertain the market value of the freehold and then derive a rent by an appropriate rental rate to the freehold value.
[42] There was evidence that the other valuers placed weight on previous lease transactions in the neighbouring block. The values differed by almost 100 per cent depending on what the landlord wanted and what the lessees were prepared to pay.
[43] I note that Messrs Hansen and Fisher accord less weight to rentals or land values agreed between the parties who are to some degree captive due to the rental review or renewal of an existing lease where neither will welcome arbitration. A lessee may be incentified by the cost of abandoning improvements and/or moving.
[44] I particularly noted that Messrs Hansen and Fisher said a prudent lessee would only pay as much rent as would produce an adequate commercial return for this particular property.
[45] Messrs Hansen and Fisher started with the traditional 7.5 per cent rate, but then tested to see whether or not the lessee could exploit the property and make a return paying that sum. They also observed that a prudent lessee would decline to pay a rent which would make development of the property uneconomic.
[46] However, in the end the commercial property the subject of the Hansen/Fisher arbitration, is far removed on the facts. It is of some help in this case, but does not displace the relevant reasoning of Messrs Dunlop and Ryan.
[47] The Court is conscious that we have in recent years lived in a very low interest rate environment but the term of this lease is 21 years.
[48] It would have to be argued that the lease would be a fair rent if you could build a reasonable quality house on the property, fitting to the quality of the neighbourhood, and then extract a reasonable rental showing a reasonable return on capital.
[49] However, the terms of the lease provide that the ground rent cannot decrease or change depending on how the lessee improves the property. If the property is residentially zoned then a prudent lessee will take into account that the property cannot be used without improvements, which will be a cost.
[50] For these reasons I do not think that this Court can set aside the valuation by Mr Davies, as 5.75 per cent is well within acceptable rates for the long term lease of land, and specifically justified by the 2 Sheridan Lane rental.10
Conclusion
[51] On the evidence before this Court, as discussed in this judgment, I find that the rental sought has been defended by three expert opinions so that on the evidence before the Court, it is more probable than not that the rental sought is a fair annual rent.
[52] I declare that I am satisfied that the valuation by Mr Davies is the valuation which the landlord is entitled to rely upon and has been vindicated in these proceedings.
[53] The result is that the lessor is entitled to the relief.
[54] The landlord has responsibly suggested that this Court make orders, to lie in Court, pending sealing, to give time for Mr Bird to reconsider his position. Accordingly, there will be the following orders, to lie in Court:
(a) An order for possession for all that land described in leasehold
Certificate of Title identifier 432884 being Lot 217, Deposited Plan
53885 (North Auckland Registry);
(b) An order that lease instrument L7866016.1 be cancelled;
(c) An order that the respondent pay the outstanding rental, interest, costs and outgoings accruing up to the date of cancellation or any later date on which the respondent yields up loss, subject possibly to some
qualification;
10 See above at [18].
(d)An order that the respondent pay compensation to the applicant including in respect of the respondent’s failure or refusal to yield up possession to the applicant; and
(e) An order that the respondent pay the applicant’s costs and disbursements including in respect of serving Property Law Act 2007 notices and notice of intention to cancel, subject possibly to some qualification.
[55] These orders should be filed in the Court in the forms of a draft order for sealing, but to lie in Court for a period of two months, from the date of filing.
[56] At least one week before the two calendar months expire, Mr Bird will file any further submissions. The landlord may reply within a further week.
[57] Mr Bird, you have a right of appeal against this judgment to the Court of
Appeal.
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