by Richard Smith
This article summarises the Government’s legislative proposals for the deregulation of the private rented sector and the application of the Business Expansion Scheme to investment in that sector.(1) Deregulation and tax incentives are the principal means by which the Government hopes to revive the sector, but whether they will work is a matter of debate. This article is designed to help the reader to make an informed judgment as to the likely impact of the legislation and the prospects for investment. In making that judgment, however, the reader should bear in mind that the other proposals in the Bill for extending the role of housing associations and reducing that of local authorities as providers of housing may also be significant.
If the legislation regenerates the PRS, the practising surveyor can look forward to playing a vital role in the development and management of residential property comparable to that presently undertaken in the commercial sector. Only time will tell. But the signs are that there will be a significant expansion in the PRS. So it would be as well to be prepared.
The basic problem is that the UK housing market is seriously distorted and in some parts of the country there appears to be an acute shortage. At the same time the private rented sector, which one would expect to provide for the transient and those not able to buy, is the smallest in the Western world — roughly 9% of homes. The high cost of accommodation in more prosperous areas makes moving to find employment difficult if not impossible. So although unemployment in general remains high, there are labour shortages in certain areas.
The Government favours freeing the market. It considers that the abolition of rent control would end the black market in rented accommodation, bringing in more reputable investors and increasing the supply and standard of houses and flats.
What does the Bill propose?
The assured tenancy
The standard type of tenancy under the new legislation is the assured tenancy. Any new lettings which would have been Rent Act tenancies will be assured tenancies and the list of exceptions is similar to that in the Rent Act with the notable omission of housing associations, which are to be brought within the new regime.
The principal differences between regulated and assured tenancies can be summarised under four heads:
(a) Market rents and premiums
There will be no rent control in assured tenancies and it will be lawful to charge premiums.(2) During the term of the tenancy the rent may be increased according to the terms of a rent review clause, should one be incorporated. On the expiry of the term, the tenant may wish to remain in possession: so, the landlord may serve a notice of increase of rent taking effect no earlier than the expiry date. He may serve further notices annually. The landlord’s notice takes effect unless the parties agree a different rent or the tenant refers the matter to the local rent assessment committee. The RAC will set a market rent according to assumptions and disregards similar to those which apply to business tenancies under the Landlord and Tenant Act, and will therefore exercise a function similar to that now exercised by the court in business tenancies.
(b) Reduced security of tenure
In an assured tenancy there will still be security of tenure, although there will be fewer barriers to the recovery of possession; in an assured shorthold tenancy (see below) there will be none.
As to security, no tenancy can be ended by the landlord without a court order. On the expiry of the contractual term, a statutory periodic tenancy arises unless the tenant quits or the landlord obtains a court order. No order may be made unless the landlord establishes one of the mandatory or discretionary grounds for possession set out in Schedule 2. These are similar to those in the Rent Act but there are some new mandatory grounds, most notably:
(1) three months’ arrears(3) of rent at the date of the landlord’s notice of proceedings for possession and at the date of the hearing. Under the Rent Act, arrears are only a discretionary ground and frequently courts suspend possession orders on condition that the arrears are paid off. The cost and delay involved in recovering rent is considered to be a substantial disincentive to letting. (Persistent delay in paying rent was also to be a mandatory ground under the Bill as originally drafted but has now been relegated to a discretionary ground. This is more in line with the Landlord and Tenant Act which gives the court a discretion to grant possession, but only for persistent delay in paying rent.)
(2) substantial works of construction, reconstruction and demolition. This ground is almost identical to ground (f) of section 30 of the LTA but cannot be exercised by a landlord who has purchased the reversion over the head of a sitting tenant.
(c) New terms
As in business tenancies, the landlord or tenant may propose new terms on the expiry of the contractual term; unlike business tenancies disputes will be settled by the RAC which should be quicker and cheaper than the court.
The RAC will accept proposed terms if they are reasonable for such an assured tenancy disregarding the fact that the tenant is in possession. The rent may be adjusted accordingly (up or down). If the judicial approach to lease renewal is anything to go by, landlords will be hard pressed to justify new terms. But the RACs may adopt a more flexible approach.
(d) Limited right to succession
A periodic tenancy vests in the spouse of a deceased tenant, provided the tenant was not himself a successor or a surviving joint tenant. “Spouse” includes a person living as husband or wife of the tenant.
Unlike the Rent Act, there is only one succession and members of the family other than the spouse have no right to succession. Death of a periodic tenant (whether contractual or statutory) with no succeeding spouse gives the landlord a mandatory ground for possession against the person inheriting the tenant’s estate, provided he commences proceedings within 12 months of the death or within 12 months of his knowledge of the death. This improves the liquidity of the investment, for it will not be tied up for generations.
The assured shorthold tenancy
Although the assured tenancy is the standard type of tenancy, a variant, the assured shorthold tenancy, may be more attractive to many landlords who fear management problems with bad tenants, for the advantage of the AST is that it confers no security of tenure at all. Yet the landlord will still be able to charge a market rent. The Government has been criticised for employing a misleading name for this tenancy. It is claimed, with some merit, that there is nothing “assured” about an assured shorthold. However, the AST is a type of assured tenancy — the basic definition, the exclusions, the tacking on of a statutory periodic tenancy and the requirement of a court order all apply to the AST.
(a) No security of tenure
So long as the tenancy would be an assured tenancy but
(i) is for a minimum of six months, and
t(ii) he tenant is given notice in the prescribed form telling him that he is getting an AST,
then an AST is created. The court must grant the landlord possession if he requires it, provided the contractual term has ended. Of course the landlord may allow the tenant to remain in possession, in which case, just as in an assured tenancy, a statutory periodic tenancy arises on the same terms. The landlord may also propose an increase in rent or new terms or both. If the tenant does not agree to the changes then the landlord has the option of finding a new tenant who will.
(b) Market rents
The landlord of an AST may charge a market rent, but if the rent is excessive — ie significantly higher than that of similar assured tenancies or ASTs in the locality — the tenant may apply to the RAC for a determination of a market rent. The determination will not be backdated but, subject to that, takes effect when the RAC decide it shall. A controversial provision requires the RAC to make no determination if there are not sufficient comparables on which to base a decision.
A determination may only be made in respect of the first AST between the landlord and tenant. Subsequent rents are solely a matter of negotiation between the parties — the tenant is exposed to the forces of the open market.
One may be forgiven for wondering why a landlord should choose an assured tenancy when he can employ an AST. There are two principal reasons. One is that the Business Expansion Scheme (below) only applies to assured tenancies. The other is that in some circumstances an assured tenancy may attract a higher rent because of the added security — the landlord may decide to trade liquidity for a higher rate of return. For this to be widespread the market would probably have to be better balanced than it is, but the Government hopes that by attracting more landlords such a balance can be achieved and that rents will eventually arrive at a reasonable level.
Resident landlords
There will be no statutory protection of any sort for tenants who share living accommodation with their landlords. Furthermore, the old requirement of a court order for possession is abolished for “excluded tenancies and licences”. These include not only tenancies granted by resident landlords, but also holiday lettings, temporary accommodation for squatters and hostel accommodation provided by a public body. So long as the tenancy or licence has been properly terminated according to its terms, the landlord or licensor could, for example, wait until the tenant goes out and then change the locks. It is thought that if people are to be encouraged to let their homes, they must be allowed to do so in the knowledge that litigation will not be necessary to get lodgers out.
Phasing out of Rent Act tenancies
The Bill will not take away the rights of existing tenants. They will continue to be protected under the old legislation. This is so even if the landlord grants a new tenancy to an existing tenant — whether of the same or of different premises.
However, in order to speed up the disappearance of regulated tenancies, the Bill modifies succession rights. First, it alters the rules for succession to a member of the tenant’s family by increasing the residence qualification from six months to two years. Second, it provides that a member of the family (but not a spouse) who succeeds to a tenancy only obtains an assured tenancy. One of the effects of the latter is to abolish the second succession where the first successor was not the spouse of the tenant.
Rent officers and housing benefit
One of the consequences of housing benefit is that it tends to push up the overall level of rents. But what the Government particularly wishes to prevent is the case where a tenant agrees to pay an excessively high rent because he is financed either wholly or in part by the taxpayer through housing benefit. [Something similar happens now in that private landlords will charge market (or higher) rents to tenants on benefit. Consequently local authorities are increasingly using their power to refer private rents to the rent officer to reduce their housing benefit obligations. Significantly, this power will be abolished by the Housing Bill.] Accordingly rent officers will be given a new responsibility. They will have the difficult task of deciding in each case where benefit is paid whether:
(a) the rent is excessive, or
(b) there is “overaccommodation”, ie more space than is necessary for the needs of the tenant and his family, or
(c) the accommodation is too luxurious.
No government subsidy will then be paid to the local authority paying benefit in respect of that part of the rent which is deemed to be excessive. If local authorities do not make up the difference, tenants will have to make it up themselves or leave.
The Finance Act 1988 and BES
The BES was designed to encourage investment in certain types of new business ventures. A taxpayer who buys new shares in a qualifying company not listed on the Stock Exchange or the Unlisted Securities Market may claim income tax relief on the amount invested. For example, a top rate taxpayer investing the maximum of £40,000 pa would have a gross investment of £40,000 at a net cost of £24,000. Not only this, he would pay no capital gains tax on a first disposal of the shares. The tax benefits are available only if the shares are held for at least five years. The Finance Act applies the BES to a company which makes available qualifying(4) assured tenancies for a period of at least four years from the date it issues the BES shares. If properties are not newly built, they must be unlet at the time of acquisition. The maximum capital value of each house or flat will be £125,000 in Greater London and £85,000 elsewhere so that investment is not concentrated only at the “yuppie” end of the market. Assured shorthold tenancies are excluded because the purpose of the BES is to encourage the long-term provision of rented property.
There is a ceiling of £5m on the total amount of BES investment in a company in any 12 months. To qualify for relief, investments must be made before December 31 1993.
A company does not qualify if
(a) it carries on other trades, or (b) it is controlled by another, or (c) it has a subsidiary not fulfilling the BES conditions.
An investor does not qualify if
(a) he is a paid director or employee of the company, or (b) he owns more than 30% of the capital or of the voting power, or (c) he controls the company, or (d) he is a tenant of the company.
It is the general view of tax experts(5) that the application of the BES to assured tenancies will be very attractive to those looking for a tax shelter. Recently, similar schemes have been successfully employed by high taxpayers — notoriously Terry Wogan and other celebrities who invested in woodlands.
The end of this shelter leaves the Wogans of this world looking for alternative investments — preferably asset backed, and therefore low risk. Many BES schemes are high risk for, by their very nature, they are concerned with fledgling businesses and have few assets behind them. Not only this, it may take some time for the rewards to materialise, although when they do they can be very high. All these factors, as well as the disappearance of other tax shelters, make investment in assured tenancies attractive.
Stephen Rowe, managing director of BES Investment Research, reckons that if a BES investment by a 40% taxpayer increases in value by 10% for five years, it could be matched only by a conventional investment increasing at 29.6% for the same time.(6) He takes the view that the BES will play a role in re-establishing the rented property sector in this country.(7) Johnson-Fry, the UK’s leading sponsor of BES share issues, have stated that they will be concentrating on assured tenancies, partly because the investment ceiling for other BES schemes is only £500,000 (except ship chartering) compared with the £5m for assured tenancies.(8) It would seem, therefore, that substantial sums will be invested in new companies in the business of providing assured tenancies. The Government estimates that the cost to the Exchequer will be in the region of £40m per year. This means at least £100m invested annually over the next five years in the private rented sector in new companies alone(9). Whether this will trigger the regeneration of the private rented sector is a matter of debate.
This debate will be taken up in a follow-up article which will examine the likely impact of the Government’s housing reforms.
References
(1) The Bill is expected to become law at the beginning of 1989. At the time of writing it has completed its passage through the House of Commons.
(2) But if a premium is charged the property will not qualify under the BES.
(3) This varies slightly according to the length of the lease and the payment of rent.
(4) The property must be fit for human habitation, have all the standard amenities under the Housing Act 1985 and be subject to no premium.
(5) See, for example, Accountancy Age, March 24 1988.
(6) Accountancy, February 1988, p 87.
(7) Accountancy, May 1988, p 31.
(8) Accountancy Age, March 24 1988.
(9) Judging by the number of BES schemes already floated, this may prove to be an underestimate.