Flat management companies: Get the details right

A recent UITF update on the accounting for residential management companies raised as many questions as it answered. So Jennifer Adams took the opportunity to review the company structure options available.

AccountingWEB’s coverage of UITF 92 on residential management companies’ financial statements provoked several comments from members that suggested it might be a good time to remind accountants of the different  ways residents can own and manage their flats, including the RTM - “right to manage” company.

Register with AccountingWEB.co.uk and log in to see full details for the following approaches:

  • Resident management companies
  • Company limited by shares
  • Company limited by guarantee
  • An interesting problem
  • Right to manage companies
  • Setting up an RTM
Jennifer Adams FCIS TEP ATT is a freelance writer and author specialising in tax and company secretarial issues, and can be contacted at Abacus Business Solutions

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Comments

Flat Management Company - limited by guarantee

giff78 | | Permalink

Hi Jennifer

 

should the property be held on the balance sheet of the company at market value?

if so, should a professional valuation be obtained or would a director's estimate suffice?

 

thanks and regards

 

giff78

Surely the company (in

DavidACA82 | | Permalink

Surely the company (in whatever form) does not own the propery, merely the freehold?

freehold

giff78 | | Permalink

one would assume the freehold value is in the land and not the building itself

regards

giff78

Freehold values are actually

DavidACA82 | | Permalink

Freehold values are actually very low, and not based on the value of the land as such. How would you seperate the value of the land from the value of the properties built on it? You couldn't use the value of the land before any properties were built either as the value at that time would have included a premium for development potential.

Freehold values are usually based on the future income that owning such a freehold would generate. The thread on the following discussion forum is quite a good example - http://www.landlordzone.co.uk/forums/showthread.php?6345-Buy-freehold-or-not-Auction-vs-enfranchisement

So if you wanted to value the freehold in the accounts, I would have thought a simple formula like the one in the thread would be sensible rather than incurring professional fees on such a low value asset. Someone who practices in this area may be able to offer a more experienced view, but values must be too low to get overly flustered.

I have not dealt with freeholds at all in a professional capacity, I merely looked in to it once as potentially somewhere to spread my savings (buying commercial freeholds at a property auction) but decided against it pretty promptly!

 

David.

Freehold Value

JSaunders | | Permalink

Another way of looking at the value of the freehold....  usually the company will make long leases to the tenants of say 99 or 999 years.  On the basis that the property is subject to such long leases, what would you be prepared to pay to obtain the freehold?  Nothing, unless there was an income stream, in which case you would pay an amount equivalent to the present value of the future income stream - similar to any other investment property. 

values

tom2another | | Permalink

As in any company's accounts the freehold is entered at cost - unless there is a compeling reason not to ( never come across one.).

The history of how the company aquired the freehold will dictate the cost, as freeholds aquired seperately from the original leasaes usualy cost more.

Nothing fancy about it.

Giff & David show a lack of knowledge relating to the law of property.

The owner of the freehold land also owns everything attached to the land - ie the buildings. These are then leased out as leaseholds. When the lease runs out, the use of the property reverts to the freeholder.

If the owners of the freehold company are the same as the lease holders, no problems. If seperate then interesting.

One of the reasons to purchase/own the freehold is not just to collect the ground rent, but when the lease needs renewing, or extending (don't forget lenders want leases of 50 years plus), then you can make a killing.

Tom

Freehold Value

Hollyhurst | | Permalink

1.You do not want to have to spend money on valuations, with no benefit.

2. Therefore the following statement in the accounts should suffice:

" The accounts show the cost of the purchase of the freehold. Revaluation is not relevant as the freehold will not be sold in the forseeable future".

Main issue and pitfall is

uktaxpal | | Permalink

Main issue and pitfall is that Coys Hse accounts are NOT service charge accounts to be issued to leaseholders.

Paul Scholes's picture

Property at cost?

Paul Scholes | | Permalink

Interesting debate.  Where do people see these properties in terms of FRSSE and the need to show investment properties at value in the balance sheet?

stupormundis's picture

zzz

stupormundis | | Permalink

Valuation of freehold

uktaxpal | | Permalink

Valuation of freehold reversionsary interest is just application of valuation formula utilising future ground rents.

valuation of freehold

andrewparker1 | | Permalink

Interesting debate – if the leaseholders are also the shareholders in the freehold company and are compelled to sell the share for a nominal value when the leasehold interest is transferred, common sense would suggest that the value of the partial freehold interest is subsumed within the value of the leasehold interest. The directors are hardly likely to charge the leaseholders (i.e. charge themselves) to extend a lease that is running low and unless the company is making a profit on the ground rent the reality seems to be that there is no value in the freehold in these situations.

As common sense is not an accounting policy no doubt the above is flawed.  

Demonstrates why these issues

uktaxpal | | Permalink

Demonstrates why these issues are best left to specialists?

freehold for sale

andrewparker1 | | Permalink

Details:

  1. leaseholders bought freehold via newco and leaseholders and shareholders are the same individuals
  2. Articles prescribe that the share has to be transferred at a nominal value when the lease is transferred
  3. some new leases in place and others to be put in place as and when required at a peppercorn ground rent for 999 and freeholder does not charge the leaseholder for the new lease (i.e. they do not charge themselves again as they already paid this when the bought the freehold).
  4. where an older lease is still in place (and the ground rent is somewhat greater), the freeholder has agreed to set the ground rent off against that leaseholders other costs. Slightly irregular but it works to balance out the problem of old leases and new leases.  3) will follow with the old leases as soon as these remaining leaseholders get their act together and pay a solicictor.

How much would uktaxpal like to offer me following the valuation? If the answer is nothing where has the value of the freehold gone (which was bought for a substantial sum only a few years ago)?

True there are variations on this where each leaseholder has not bought into the freehold. The intention of the legislation was to transfer power to the leaseholder. Value inevitably follows. Just because there is no accounting mechanism for it (Dr leaseholder, Cr freehold in Co. does not work) does not mean it has not happened.

In theory leasehold flat is

uktaxpal | | Permalink

In theory leasehold flat is worth less without freehold.So,by purchasing freehold flat is worth more?At least the unrelated freeholder is removed and replaced by residents.

Ground rent should be retained to pay costs which are usually the landlords responsibility and pay for costs not included in the lease.

The freehold is only a reversionary interest.It cannot be used for 1000 years.What use is that.The flats will have been demolished or fallen down by then.Who knows what conditions will exist in 1000 years time?At best you have a share in freehold land when the flats fall down.

The less the unexpired period of the lease term when you purchase the freehold the more it will cost.When did you purchase the flat and how many years were left unexpired on the lease?

 

 

998 years later

andrewparker1 | | Permalink

and the leaseholders have neglected to renew their leases. They have a year left to run. Will the freehold company (owned, managed and controlled by them) charge them full value or a nominal amount to renew?

Control over the destiny of the freehold rests with the leaseholders as was intended. These companies hold no value until the leaseholders collectively decide they do. Where the freeholder company is not owned by the leaseholders you are correct and this was always the case.  

During that 1000 years I

uktaxpal | | Permalink

During that 1000 years I would expect the leaseholders will either have to rebuild the flats or demolish them and therefore the company will need to charge for this work.They could develop the land for other uses subject to planning.1000 year leases are really theoretical.

exactly?

andrewparker1 | | Permalink

Seems to illustrate the point that control over the freehold rests with the leaseholders. The leaseholders would be funding the rebuild. The freehold company (controlled and managed by the leaseholders) would not independently rebuild and charge them if the leaseholders had not first decided to rebuild. Difficult to see how value in the freehold can be divorced from the leaseholders who have complete control over it in their capacity as leaseholders.  

Distribution in kind

The Limey | | Permalink

andrewparker1 wrote:

If the answer is nothing where has the value of the freehold gone (which was bought for a substantial sum only a few years ago)?

There has been a distribution (dividend) to members. Similar issues to Aveling Barford. Failure to account for that would mean the accounts fail to give a true and fair view. 

@AP1 Agreed.Make sure

uktaxpal | | Permalink

@AP1 Agreed.Make sure leaseholders are competent.Leaseholders can manage their own flats but this can be more of a disaster than having an unrelated landlord.

@L Not usually as FMC articles do not allow dividends.

Residents will still need to pay costs that were the responsibility of.the outside landlord.Costs can be raised from leaseholders via ground rent or service charges if lease permits.

May be worth asking an insurance company what they would pay for a freehold reversionary interest maturing in 1000 years time.

Still probably a distribution

The Limey | | Permalink

uktaxpal wrote:

@L Not usually as FMC articles do not allow dividends.

Then you need to ask yourself if entering into an under-priced lease with a shareholder was legal.

@L Parties are free to

uktaxpal | | Permalink

@L Parties are free to negotiate whatever bargain they chose.Only time legaity is an issue is say duress/undue influnce/misrepresentation.

 

Unless they did not have the

The Limey | | Permalink

Unless they did not have the powers to enter into such a bargain (it would ultra vires). The value of the freehold has been impaired because of a contract (lease) entered into with a shareholder. That sounds very similar to a deemed distribution of an asset to me.

 

Of course, you have recorded the impairment haven't you?

What a mess?

andrewparker1 | | Permalink

Not a distribution in the first instance as leaseholders pay full value for the initial grant of 99 or 999 when the freehold is bought from the original third party freeholder. What we are saying is that once the leaseholders are in control the value is passed to them at that point for full cost and then more or less stays with them in perpetuity so no question of a future distribution.

I act for a few of these tin pots. They only have a few leaseholders and they cannot do anything with the freehold unless all leaseholders collectively agree. Whilst I think it is true that there is no value in the freehold company in these situations it might not be the case in larger companies where decisions over the freehold can be made without the consent of all leaseholders. Is this a mess?    

Do the leaseholders pay or

The Limey | | Permalink

Do the leaseholders pay or does the company pay? I have to say it's probably one of those situations I'd run a mile from! And do any of these companies really prepare stat accounts that require a CA audit?

@L Freeholds have become more

uktaxpal | | Permalink

@L Freeholds have become more valuable as interest rates have fallen.

Most memos of FMC allow purchase of land etc.

Developers see freehold retention as additional profit but the ideal would be transfer the freehold to the leaseholders on completion of the deveopment.

Leases can be varied to increase ground rent and thus make freehold reversion more valuable but who is now going to purchase a freehold with all the laibilities and responsibilities which follow?

Dont think audit is a problem.Just explain the facts in the notes to the accounts.

Paul Scholes's picture

In reality it's all academic

Paul Scholes | | Permalink

I would guess that there are hundreds of thousands of these companies on the books and whilst, as a Ltd Company with members, they could in theory turn their hand to anything, the very nature of their existance, ie that members regulary come & go as they buy & sell their dwellings, they tend to just run along as a legal nicety, holding the freehold reversion for members X years in the future to do something about when the leases approach their end (ie extend them).

In most cases the companies are set up with constitutions that tie in the leaseholders to run the company for the benefit of current & future leaseholders and modern leases reinforce this commitment.  So, for example, most companies have no shares, ie they are ltd by guarantee and, individuals can only be members whilst they own a dwelling.  Even on a winding up most constitutions dictate that any remaining assets have to be distributed to another similar organiastion.

So yes, the value of the freehold may be relevant if all the flat owners get together and decide to break the confines or the articles (and, if necessary, leases) and take it on as a commercial development of some kind but, in the vast majority of cases, they just tick along as residents with a paper landlord.

Having dealt with loads over the years, getting a block of a dozen disparate flat owners to decide who should do the gardening is difficult enough so I can't imagine too many being able to club together to do something extraordinary with the property as a whole.

In line with company law?

The Limey | | Permalink

I'm not really coming at this from the line of what's relevant (which of course depends on the various stakeholders), but from what's in line with accounting requirements and company law.

Any choice to deviate from those, for example by stating that "The accounts show the cost of the purchase of the freehold. Revaluation is not relevant as the freehold will not be sold in the forseeable future" if applicable accounting standards did-not allow a policy of holding at cost (eg UK GAAP for investment properties, which a freehold interest almost certainly is) would require a true and fair override for the accounts.

 

If the argument was given that the company wasn't holding for gain, but merely as a legal entity to hold the rights for leaseholders then I think everybody would agree that the company would be acting as a nominee company (ie agent) and therefore the freehold interest should not have been recorded in the accounts in the first place.

Paul Scholes's picture

At value

Paul Scholes | | Permalink

My understanding (and practice) has always to be to follow FRSSE and include the freehold reversion at value in the balance sheet.

As I said, in most of the cases I come across the members (ie leaseholders) can not get their hands on the value (either now or in 999 years), and so the Ltd company holds the interest for itself.

Obviously, as I say, things can change ie the members could rip up the constitution & leases and do something else, which might mean a change in accounting but I've yet to come across such a situation.

Sorry - the quote wasn't from

The Limey | | Permalink

Sorry - the quote wasn't from you but was just using it as an example of what it appeared people were saying! Yes, I think FRSSE would have to be followed in most cases so therefore at Valuation. However, Valuation would have to include the under-value leases given out. I'm fairly sure that, if insolvency ever became an issue or there were disputes, the granting of those leases would be deemed to be distributions. Of course, that doesn't mean they have to be accounted for as such!

For a company limited by guarantee, I would be very wary about granting under value leases unless it's specifically allowed by the articles and it was approved unanimously by a general meeting.

The value is in the long

uktaxpal | | Permalink

The value is in the long leases.How do you arrive at undervalue?

Because they are granted at

The Limey | | Permalink

Because they are granted at below market rates such as (to use the example above) a peppercorn. 

Dont forget there are two

uktaxpal | | Permalink

Dont forget there are two transactions here which can arise at different times:

 

         1/Purchase of freehold-Ground rent still normally payable unless leases varied.

         2/Lease extension-statutory formula-Lump sum usually paid to landlord which

            includes advanced ground rent and varies with length of lease term unexpired

            at date of lease extension.

 

Question of undervalue does not therefore arise.

Paul Scholes's picture

Undervalue and distribution

Paul Scholes | | Permalink

@The Limey - a typical (and now probably frequent) situation in which this can occur is presumably when lease lives start to deplete to the point at which the leaseholders will wish to use their right to extend the leases.

Depending upon the unexpired term, and certainly once 80 years had been reached, a third party landlord would look to negotiate a market premium for the lease extensions, but in the case of a FMC owning the freehold it is usual for the leaseholders to agree nil value and just share out the legal costs.

In such a situation I can see how the Ltd Company has given up its right to negotiate a market premium in favour of its members which, on the face of it, indicates a distribution which, in such a company, is actually ultra vires. Presumably therefore the leaseholders have to compensate themselves?  And so we go around in circles.

I don't know the legal get-out but there must be one as it happens all the time.

With regard to the value in the accounts, obvioulsy once the above situation is reached the thing is pretty much worthless.

 

 

@Paul -

The Limey | | Permalink

@Paul -

 

Exactly the situation where I'd have concerns! And in particular, I'd have even more concerns if the leases expired at different times and therefore only certain leases were being extended at each point (and thus members not being treated equally as a body at that point in time).

Your point about legal get out is what I was aiming at when I said I'd want it to be in the constitutional documents and agreed unanimously in general meeting (or at least as a special resolution I suppose). You're probably right though, some sort of legal clarity on this would be welcome. I suppose somebody must have looked at it.

RMC Accounts Format

shaka198 | | Permalink

Does anyone know where I can get an accounts template where freehold is owned by a company owned by all the leaseholders?