As the credit crunch continues and house prices come under threat and as the market goes through a period of price correction after several years of rapid advance, the prospect for the private landlord is thought by many to be bleak. However, it may prove to be just the window of opportunity required to provide a stable, well controlled and desirable form of tenure and, above all, sustain a real choice in housing.

ARLA has long campaigned for light touch regulation of the Private Rented Sector and with a level playing field for all concerned, landlords, tenants and agents. We would welcome encouragement from Government to extend the scope of licensing within the PRS, and to have redress available to landlords and tenants should agents and managers fail to provide a satisfactory level of service.

It had been hoped that Government would have taken the opportunity to include letting agents when they were introducing a mandatory redress scheme for Estate Agents. The opportunity was missed and the definition included in the Estate Agency Act of 1979 was used instead. However, at the time of writing, even this element of consumer protection has been delayed by Government as the introduction of Redress for Estate Agents has been put back, from April 2008 to, possibly, October 2008.

Licensing for all agents

The framework for the structure that ARLA would like to see requires for agents to be licensed. Part of the obligations of that licence would be to ensure that all the properties being rented out through their offices complied with a minimum standard based on the HHSRS legislation, contained with the Housing Act of 2004. Licensing would, of course, go much further than that for Agents. It would require them to be members of a redress scheme, such as operated by the Ombudsman for Estate Agents. It would also require agents to have professional indemnity insurance and client money protection to cover those funds not protected under Tenancy Deposit Schemes.

Where a landlord wants to carry out the management of the property, the requirement would be to subscribe to an actively managed accreditation scheme operated by the local authority. Many local authorities are currently establishing such schemes but they are being operated by default in as much as landlords can self-certify. Self-certification can only work within a framework that allows enforcement by the authority. Where the local authority is operating a scheme, it is - and would be - wrong for the consumer, ie the tenant, to have to instigate complaints.

Instead, there needs to be a proactive approach from the local authority as a tenant instigating a complaint to their landlord is in a very vulnerable situation. Less than reputable landlords are known to carry our “retaliatory eviction”. In most cases this is actually legal, but it only serves to move the problem on from one tenant to the next.

Should it be necessary to make amendments in this kind of case, then perhaps consideration should be given to HHSRS action being mandatory before re-letting takes place.

The Scottish model

Scotland has introduced a landlord registration scheme where a landlord has to register with the Local Authority and be seen to be a fit and proper person. The landlords can face penalties should they fail to act correctly. This has now been supplemented by the requirement to have a Chapter 4 Notice under the Housing (Scotland) Act of 2006. This requires a landlord to confirm that the property will be maintained within the standards set for repairing obligations; and it advises the tenant of their rights to go to the Private Rented Housing Panel to have repairs carried out.

Unfortunately Government and Local Authority have combined in failing to ensure that all landlords are registered. Again, consistency across that particular part of the UK is falling down.

These frameworks can provide the controls to regulate the Private Rented Sector, but where are the incentives to encourage a landlord to act responsibly, to ensure the number of cases requiring action can be kept to a minimum?

It is well documented that, although the small landlord market splits into several parts, it is basically dominated by older property, (much of it in need of modernisation and upgrading) and new build property being purchased mainly in the city centres by Buy to Let investor landlords.

Fiscal Opportunity

Landlords, generally speaking, are not treated as businesses within the fiscal regime. This can be a very real disincentive to providing well managed, well maintained property for certain parts of the market.

The following ideas could be described as a wish list, ideas that could work to encourage landlords to invest in certain sectors of the market and, at the same time, help improve the quality of the UK housing stock.

One of the main concerns of both Central and Local Government is how to improve and maintain the quality of the fabric of older property, in particular within inner city areas.

Much of this stock has, or is, being allowed to fall into disrepair and has been left below a tolerable standard. Grants are not always or often available and they can be a slow and cumbersome method of achieving satisfactory results.

Government has produced figures indicating the number of new homes required to meet future demand. It has set a new build figure of 200,000 properties per year, which it has not been able to meet, and the future requirement makes no allowance for replacement stock.

Capital allowances

To help this situation, if a landlord was purchasing or improving housing stock, say, over 70 years old and carrying out improvements of a capital nature, replacing kitchens, bathrooms, windows or installing central heating, which would also improve the energy efficiency of the property, capital allowances should be available. Then, these works can be set against Income Tax at the time of completion as opposed to requiring them to be set against Capital Gains Tax at the point of sale or transfer. Over time this would become tax neutral, as it would have the effect of raising the value of the property under the Capital Gains Tax Computation. There could also be a “clawback” facility it the property was not kept for a given period, say 10 years, as a rental property. This would have the effect of encouraging the longterm provision of housing within the PRS.

LESA

Another option would be to increase the Landlords Energy Saving Allowance (LESA) especially to include the installation of central heating systems. LESA is an undermarketed facility and an underdeveloped tool. HMRC mention it on their website but it is left to bodies like The Energy Saving Trust to encourage the use of LESA.

A proactive approach by government would help and it could include such measures as HMRC including an explanatory leaflet with all Tax Returns where a land and property section was required and to create an automatic “pop-up” for these pages on-line.

Local Authorities communicate regularly with landlords, although they may not have an exhaustive list of landlords in their areas. However the insertion of a leaflet with Council Tax Notices would be relatively inexpensive as the postal cost is already incurred. As with all these things, once the message starts to become known like a fire it spreads.

Whilst writing this chapter, I asked several accountants dealing with landlords’ tax returns what LESA was and, not surprisingly, most did not know. Whilst I am sure their professional bodies will say that they flagged it up to their members, these bodies are yet another vehicle to get the message into the market place without the cost of press advertising.

Note to Government

However, Government please note: Make the allowances meaningful. Many of the items requiring attention are not covered. As an example, incentives should be investigated to cover blocks of flats, where obviously one landlord cannot install cavity wall insulation for his own flat unless it is the ground floor. Clearly, if there was to be a way to allow an entire block to be insulated, owner occupiers would benefit, but, it could be argued, if the Government wants us to be “green” and is serious about meeting its energy targets, consideration is needed of how best to incentivise investment landlords. Otherwise, at the risk of sounding cynical, does the Government make bold statements about Energy Saving without meaning them, or actually believing their own spin?

An option to provide a financial incentive for the purchase of property for Buy to Let would be to make changes to the Stamp Duty Land Tax. Larger investor landlords are put off buying blocks of property as the SDLT is based on the total value of the transaction, rather than being based on the value of individual properties within the block. This almost always has the effect of the duty being at the highest rate, although in some areas the individual property may be below the £125K threshold. Again, Government incentives could be provided to purchasers of older property where a survey report and an Energy Performance Certificate show a property is likely to benefit from investment.

Where this is the case, and the landlord does the work within, say, 12 months of purchase, the Stamp Duty could be refundable. And, if appropriate, this could be clawed back again if the property had not obviously been available for rental for a period of perhaps 10 years.

Government needs to be aware that many Buy to Let landlords have purchased their property in the expectation that it will provide a pension on retirement having left the pension market because of unsuccessful meddling in Capital Gains Tax by the Chancellor of the day, Gordon Brown.

Now, as Prime Minister, Gordon Brown oversees a housing crisis. Property that could have been suitable for the Private Rented Sector is rendered unavailable by the lack of available funding.

It should be remembered that when control of the Bank of England was taken away from the Government, we were told that its independence would help create stability. Instead we have market forces contradicting each other, with the need for cheaper borrowing to prevent potential homelessness set against the requirement to keep the rates higher to prevent inflation.

Around the same time as the Bank of England became independent, we were promised that the Government would not borrow to finance public spending, as had been a previous left of centre policy. Today we have a higher level of borrowing by Government per head of the population than we had in the days when the International Monetary Fund told the Chancellor of the day how we required to control and reduce our National Debt.

And what about VAT?

A further fiscal option could be to allow for Value Added Tax to be reclaimed for certain types of transaction. Landlords have, of course, to pay fees to a letting agent. These are subject to VAT. Part of this transaction is for the collection and transfer of monies which, it could be argued, under European Guidelines, is not a VATable service anyway.

Again, the removal of VAT on the purchase of materials and labour for capital expenditure to improve older property brought into the rental market would be an incentive to the landlord and could become tax neutral as well. Obviously a VAT receipt would be needed as proof of the works carried out which would prevent the “black economy” transactions where contractors are paid cash in hand. The construction industry has always been one of the areas where HMRC has had concerns over the amount of work believed to be cash in hand. If a landlord was sufficiently incentivised to have a VAT receipt then the market for the black economy in that area would dry up.

Availability of Finance

 The financial markets are going through a huge turmoil. Lending institutions are withdrawing mortgage products on a daily basis, some lenders have almost closed their books to new business. This is going to have an impact on Buy to Let and the small landlords which could put at risk the recovery of the private rented sector and could leave people unable to secure property under any form of tenure. Some landlords who have had facilities with their lenders allowing them to go out and purchase property for the rental sector are finding this facility being reduced or in some case withdrawn at the point when a purchase was about to settle.

If Government was to step into the mortgage market, it could encourage landlords to support the private rented sector by expanding their portfolio and stop others from quitting the sector all together.

This is, potentially, a difficult area for Government, as most lenders, it would appear, will require time to recover from the amount of so called sub-prime debt to work its way out of the financial system, and to have the resources or willingness to lend to each other. Lenders are going to be restricted to lending repayment and any margin between interest income and loan interest paid on their book. However a requirement that an agreed percentage of their mortgage lending portfolio must be made to investor landlords would be a light touch of regulation which could assist in ensuring at least a steady flow of rental property to the market.

This would also help to ensure that the lender was looking for the quality deal, where the market research had been properly carried out and the landlord/ borrower was adhering to reasonable and sensible predictions on rental demand and level from experts in the area, not on a developer over-hyping his own development.

As the Economics Editor of The Sunday Times has pointed out, there could be a downward spiral of lending but there is nothing radical about mortgage lending by Government. This could be done to assist investors in the Private Rented Sector and could stop high borrowing rates from creating inflation.

Capital Growth and Capital Gains Tax

The mortgage famine has unfortunately come at a time when Government has chosen to amend Capital Gains Tax rules, which many commentators believe could lead to landlords selling property before prices fall, or fall further. Whilst not necessarily subscribing to the selling theory it does have to be pointed out that rental income struggles to cover mortgage payments in some areas and this cover is obviously dependent upon the size of borrowing.

However with rental yields varying at about 4-5% on cash purchases and negative to very low return applying in some areas given average gearing (Source ARLA Quarterly Index 4th Quarter 2008) landlords have been - and still are - dependent upon the prospect of capital growth.

The contribution of Buy to Let

A stimulus is needed, even if short term, to protect the contribution from Buy to Let landlords to the whole UK economy. This was estimated in 2006 by Prof Michael Ball to be £30bn per annum, greater than all the pubs hotels and restaurants in the UK and four times that of the motor industry. (Source: Buy to Let the Revolution 10 years on. Available on the ARLA website www. arla.co.uk)

This was where Buy to Let started out in the mid 1990s with warnings from ARLA, who were instrumental in creating the product, that prudence would be required. This meant that borrowing levels should not exceeding 75% loan to value, and calculations should also be based on allowing adequate void periods, adequate resources to keep the property up to a reasonable standards etc. Greed by the money men and the speculator caused this to be ignored in certain areas despite continuous warnings from ARLA and the ARLA Group of Mortgage Lenders and the other professional bodies.

The Future

The future, despite all the doom and gloom, is actually very bright for the small landlord. We have a growing population, particularly among those parts of the population that create the tenant market, including the immigrant population, the student market, the elderly market, and the mobile population who change jobs and areas in way that was not thought possible a generation ago.

More than ever, investor landlords should do their market research with more than one expert in each and every local market. Ask the relevant questions about a property. Ask about tenant demand. What are the likely void periods? What running costs should be taken into account? Have you rented similar property, and if so at what price?

The potential landlord should not be fooled by thinking that the internet gives the answers. It can be used to gain a first impression but it is a superficial picture of what is available and at what rent. Websites do not show what rent was really achieved, the sort of tenant and how long it took for the deal to be done.

Even with the various potential boosts for Buy to Let landlords discussed here, the rental yield is never likely to vastly outstrip the cost of borrowing. It has always been well known that the higher the rate of return, the greater the risk. Equally, however, it has also been well proven over long periods of time that property values increase. The investor must be prepared to make a longterm commitment, unlikely to be less than 10 years and then there will be a return sufficient to make the investment properly satisfactory.

For example, a property bought for £180k with borrowings of 50%, capital growth, and provided that the interest and rent balance each other out, the actual capital investment is £90k, providing for a capital growth 10% gross on the cash invested as the lender does not take any of the capital growth.

Landlords do face a changing market place. They probably will face some more legislation/regulation to ensure they do the job properly, which in turn will require them to be more “professional”. This will do no harm to the industry. Over time, it will improve the image of the landlord. It will give even more people confidence in renting property, remove altogether the steadily decreasing stigma of being a tenant and provide for the long-term financial welfare of the Buy to Let investor in the Private Rented Sector in the process.

Ian Potter, Operations Manager, ARLA