Rating Manual section 6: valuation practice

Part 8: ability to pay

The Valuation Office Agency's (VOA) technical manual for the rating of business (non-domestic) property.

1. Introduction

1.1 Although rateable value is defined as the rent which at which a hereditament might reasonably be expected to let, it is not normally necessary to consider the hypothetical tenant’s ability to pay that rent. Ability to pay is fundamental to rating, but within the concept that ability is measured by what the hypothetical tenant would pay and presumably is therefore prepared to pay in rent. It is not measured by the rent the particular occupier can, or would like to, afford. This rule has not been breached where, in very particular circumstances, the courts have taken ability to pay into account. They have only done so because the actual occupier is the only possible tenant and therefore that occupier’s ability is the measure of what the hypothetical tenant could afford to pay.

1.2 Most hereditaments have a variety of possible occupiers, and any factors limiting the bid of one party will not affect the hypothetical landlord when he can look to the bids of other parties. When hereditaments are valued by reference to rental evidence, that evidence will consist of rents which inherently must have been affordable by the parties who paid them. The Receipts & Expenditure method automatically by its very structure proceeds on the basis of a commercially motivated hypothetical tenant’s ability to pay, and it is not necessary for the valuer, when using this particular method of valuation in the context of commercially profitable hereditaments, to make any special adjustment for this factor. It is only when considering the valuation of certain hereditaments which are incapable of generating a profit large enough to attract a wide range of potential tenants that in special circumstances it will be necessary to consider ability to pay. In some of these instances “ability to pay” acts as a ceiling on the value indicated by the Contractor’s Basis.

2. Ability to pay considerations

2.1 The resources and ability of the actual occupier to pay rent are not normally called into question. The circumstances of the actual occupier are not normally to be carried into the rating hypothesis. This is a principle which was robustly spelt out in the House of Lords by Earl Loreburn in Chertsey v Metropolitan Water Board [1916] 1 AC 337],

“In the calculation imposed on us by the Act of Parliament we are dealing with fictitious persons and with things that can never happen. A piece of reality like the balance at the bank of the person supposed to be the tenant (but who is in fact the owner) has no place in such a calculation. Fact is good and fiction may be useful, but a mixture of the two is hopeless………..If in estimating the rent which might be expected you may regard the financial position of the real person whom you assume to be the tenant, then the rent must shift up and down according to that person becoming richer or poorer year by year. I add that it must also shift as the imaginary landlord becomes richer or poorer. No one could have thought of such a proposition were it not that valuers are hard put to it by no fault of their own, and that fallacies flourish in a region of fancy.”

2.2 Exceptional circumstances may however arise where this general rule is displaced. In Tomlinson (VO) v City of Plymouth and Plymouth Argyle FC (1960) the Court of Appeal referred to the limited means of the ratepayers who had bargaining power ‘by virtue of their being the only bidders for the hereditament’. In this case Plymouth Argyle FC, which had very limited means, were seen as the only possible tenants for their football club, and if it ceased to exist, any replacement club would in effect be Plymouth Argyle in a new guise and still the only possible tenant, with equally limited means.

2.3 There are many instances where the actual occupier is the only potential hypothetical tenant of the hereditament, but it does not follow that the ability of that occupier to pay rent should be called into question. Lord Justice Schiemann alluded to this in Hoare (VO) v Spratling [1998RA391 at 409] when considering properties occupied by the National Trust:

“However, I am not to be taken as holding that the mere fact that (in cases such as the present with only one hypothetical tenant) that hypothetical tenant gives evidence that he would never pay any rent is conclusive. I see force in counsel for the valuation officers’ submissions that this would have potentially very grave implications.”

2.4 It may be that despite being the only possible tenant the actual ratepayer may be perfectly able to pay, though perhaps unwilling to do so. Nonetheless in negotiation with the hypothetical landlord a substantial rent may result reflecting the importance of occupation to the ratepayers. In Eastbourne BC and Wealden BC v Allen (VO) (2001) the Lands Tribunal considered local authorities’ ability to pay in relation to some council owned indoor leisure centres comprising sports halls and swimming pools. It was argued that due to central government restraints the local authorities would have been unable to pay substantial rents arrived at using a contractors basis of valuation. The Tribunal found the evidence showed the local authorities could have afforded the rents though this would have meant cutting down on other services or raising charges and that they would have been reluctant to do either. The Tribunal said:

“…we can see no evidence to suggest that either authority would have been so reluctant to take the necessary steps to find the money elsewhere that it would have closed the leisure centre rather than pay the rent demanded. On the contrary, it is clear that each authority attached considerable importance to the services provided by its leisure centre as a popular recreational amenity for its residents.”

The evidence is likely to point the same way for all central and most local government occupiers; accordingly ability to pay considerations do not arise for central and most local government hereditaments even where they are of specialised type.

2.5 There are however occasionally instances where the exceptional circumstances featured in the Plymouth Argyle case arise. In such cases ability to pay is a valid consideration and it may actually provide a ceiling value lower than that indicated by the contractor’s basis. These circumstances arise where the following considerations apply:

a. The only potential tenant is the actual occupier or another body which is likely to have the same financial standing as the actual occupier, and

b. There is evidence to show that the finances of the actual tenant are very limited (NB In the Plymouth Argyle case there was specific evidence that the finances of the only possible tenant “were in difficulties”) and will not enable a tenant to pay a rent indicated by the Contractor’s Basis . In many instances, where the only possible occupier is a voluntary organisation, the limitations of its budget are always likely to apply to its ability to pay a rent. This may also apply to certain parish councils, more particularly those administering rural areas where the services which they provide are very limited in range

3. Practical application of “ability to pay” analysis

3.1 Ability to pay considerations apply only in the circumstances indicated in 2.5 above.

3.2 Where these circumstances exist, the valuer must limit his valuation to the rent which the hypothetical tenant can be expected to afford.

3.3 The first step in this process in this process is the identification of the hypothetical tenant. Ability to pay considerations may apply where the only potential hypothetical tenant is the actual occupier or is to be found within a limited class of other potential tenants, all of whom share the same characteristics as the actual tenant. For example, a local village cricket club may be the only potential tenant of its own premises. Similar premises in a more urban area may be capable of attracting a number of various clubs. Where the only possible tenant is the actual occupier, the financial position of that occupier will be the starting point for the ability to pay analysis. Where there is more than one possible tenant, the enquiry needs to take into account the financial position of other organisations which might be in the market to take the hypothetical tenancy.

3.4 The next step involves taking a careful look at the accounts of those organisations potentially in the market for the hypothetical tenancy. It should be remembered that organisations which do not in fact have to pay any material amount of rent, might arrange their finances differently if they had to meet this additional outgoing. In Marylebone Cricket Club v Morley (VO) 53 R&IT 150 (1960), the Lands Tribunal approved the substitution of a higher level of income from subscriptions than that which the club had actually set. Similarly an organisation may not be fully realising the potential for maximising income from fund raising. Non-profit-making organisations may not be seeking to achieve this. The level of subscriptions set by other comparable organisations, and the amount which they raise from fundraising or donations may be a useful guide in ascertaining whether a particular organisation is maximising its total income. Also, it is material to consider whether other comparable organisations are making more use of their premises and achieving greater maximisation of income. Similarly in respect of outgoings it is necessary to consider whether the organisation has minimised running costs and maintenance. In Bluebell Railway v Ball (VO) 1984RA 113, the Lands Tribunal held that it was appropriate to take into account the fact that the occupier’s outgoings were reduced by the use of voluntary labour. Similarly where the direction of the occupier is provided by individuals who take no salary or expenses, it is wrong to impute notional expenses of this nature as the hypothetical tenant would have regard to this free service in making a rental bid. It is also correct to have regard to the lower rates payments due to any any charitable relief when considering outgoings, provided that it can be assumed that the only prospective hypothetical tenant would be a charity.

3.5 In other respects an ability to pay analysis proceeds in the same manner as a receipts and expenditure valuation (see Rating Manual Volume 4 Section 6) as far as the identification of the tenant’s share of the divisible balance.

3.6 The estimation of the tenant’s share of the divisible balance should be approached differently in an ability to pay analysis as compared with a normal receipts & expenditure valuation. The hypothetical tenant in an ability to pay scenario is likely to have no profit motive. In the methodology of the receipts & expenditure valuation, the tenant’s share is intended to cover interest on capital and an allowance for profit and risk. The absence of a profit motive means that it can be assumed that the hypothetical tenant of an “ability to pay” hereditament will require only a sum to cover risk and interest on his capital, ie the total cost of his non-rateable assets and working capital. While in reported cases the tenant’s share has often been estimated as a direct percentage of the divisible balance, the amount of any such percentage should be informed by the tenant’s required return on its capital. In estimating that return account should be taken of the costs involved in raising capital. Those costs may involve borrowing either at the market rate (and in this regard, the relevant rate of interest should be as at the AVD), or at a lower rate from supporters or well-wishers. Where capital is donated, the tenant’s share does not need to cover any notional interest, since the hypothetical tenant will also be the recipient of such donation. Sometimes capital may be raised through the sale of shares, and in this instance the amount of any dividends paid will need to be covered in the tenant’s share, to the extent that the capital raised was used to acquire non-rateable assets. In considering whether allowance needs to be made for contingent risks within the tenant’s share, double-counting with allowances made elsewhere (in the estimation of annual expenditure and income) should be avoided.

3.7 While profit may not be required as part of the tenant’s share, it may be that the likely occupier will require a “surplus” to assist in the development of the facility or to further other aims. The objects of the occupier in an “ability to pay” context need to be considered and this includes the destination of any surplus. In this respect too, an “ability to pay” analysis differs from a receipts and expenditure valuation in which it has been held that the destination of profits are irrelevant (even where they are diverted by statute- Port of London Authority v Orsett Union (1920 HL AC 273). This was considered in Bluebell Railway v Ball which involved a heritage railway operated other than for profit by a charity whose objectives include the acquision and preservation of locomotives and rolling stock. It was held to be correct to allow an element within the tenant’s share to be “ploughed back” into the acquisition of further rolling stock for preservation. This principle may have wider application where occupiers to whom the“ability to pay” principle applies have objectives which require capital outlays outside the hereditament, and which would be for them a “first call” on their resources, before quantifying their rental bid. It must be appreciated that these aims are not shared with the hypothetical landlord whose interest is in letting the hereditament for the best possible rent. The negotiations between hypothetical tenant and landlord are envisaged as amicable. Although the parties are differently motivated, with the tenant perhaps seeking a large surplus, and the landlord a high rent, there must be envisaged an agreement at the end with both parties prepared to compromise to greater or lesser extent, depending upon where the greater bargaining power lies. If a surplus is not necessary for the tenant, this fact will be taken into account by the landlord and will influence the hypothetical negotiations.

3.8 Reference should be made to the following decisions of the Lands Tribunal in considering the effect of ability to pay in relation to valuations:-

  1. First Class Cricket Grounds

(a) Warwickshire County Cricket Club v Rennick (VO) 52 R&IT 787, and

(b) MCC v Morley (VO) 53 R&IT 150

  1. Amateur Cricket Clubs

(a) Heaton Cricket Club v Westwood (VO), and

(b) Astley Bridge Cricket Club v Westwood (VO) 52 R&IT 499

  1. Amateur Football Club

Blackman (VO) v Lowe and Tavistock RDC 51 R&IT 74

  1. Tennis Club

Ripley Tennis Club v Snell (VO) 44 R&IT 809

  1. Rugby Club (Union)

Tyldesley RUFC v Cole (VO) 1989 LT 29 RVR 152

  1. Heritage Railways

(a) Winchester and Alton Railway Limited v Whyment 1981 RA 258;

(b) Bluebell Railway Limited v Ball (VO) 1984 RA 113