Newsletter July 2005

LHA law changes raise massive concerns amongst landlords

Mortgages for Business, a leading UK Buy to Let mortgage broker, has reported increasing levels of anxiety amongst its thousands of landlord clients about the implementation of the new Local Housing Allowance (LHA). 

LHA is the largest change to housing benefit since its introduction in 1988.  LHA provides housing benefit based on location and household size unlike the current system of housing benefit it is not based on individual rents.  The aim of the LHA is to increase tenant responsibility and choice, and to reduce barriers of getting tenants back to work.  LHA is also designed to make benefits easier to understand for both landlord and tenant alike, and to make administration improvements.

There is no firm national implementation date for LHA, but the Department for Work and Pensions (DWP) has a public sector agreement completion date of March 2008.   The scheme is already affecting many landlords in the scheme’s nine pilot pathfinder areas, Blackpool, Lewisham, Coventry, Leeds, Edinburgh, Teignbridge, Brighton and Hove, Conwy and North East Lincs.   In July further pathfinder areas will begin the scheme these being, Wandsworth, East Riding of Yorkshire, St Helens, Argyle and Bute, South Norfolk, Norwich, Pembrokeshire, Guildford and Salford.

The concern of landlords relates to the fact housing benefit tenants will have their rent money paid directly to them rather than the current situation where tenants’ rents are paid directly to the property landlord, which gives assurance the rent will always be received.

“In pathfinder areas it is now estimated 90% of housing benefit is paid directly to the tenant, there is therefore a general sentiment among landlords of concern that this mechanism may lead to increased rental arrears and in the longer term evictions.  Given the current market conditions in which landlords margins are already slimming, this initiative has the potential to only escalate the costs and risk exposure to landlords.”   Comments, Jonathan Moore, Marketing Manager at Mortgages for Business.

“If mortgage lenders echo the same wary sentiment as landlords to housing benefit based rented property sector in light of the new LHA, serious barriers to lending could appear as the majority of lenders may perceive increased risk.  Currently there is a tiny majority of mortgage lenders who will accept DSS tenants and this situation is only likely to get worse when the LHA is implemented and if landlords have problems with mortgage funding they will avoid that type of tenant altogether.”  Moore continues.

Paying benefit directly to tenants is intended to help ensure tenants are responsible for budgeting and paying rent themselves rather than having it paid for them, the Department for Work and Pensions believe this will prepare tenants for a return to work.   Problems of course arise if tenants are irresponsible and this is where the landlord’s concern lies.  Some safeguards have been put in place in recognition of vulnerable tenants i.e. those the housing authority believe are either have difficulty managing their own affairs or it is believed improbable that the tenant will pay their rent.  Again problems will occur if tenants who fall into this classification are not identified.

Many of the tenants in the LHA pathfinder areas will not have received direct payment of rent in the past and this in worrying a number of landlords.  Additionally landlords are worried by the fact once payment arrears begin they will continue to mount, as single missed payment is likely to lead to multiple missed payments.

Landlords have also expressed concern if tenants do not have a bank account, therefore creating a need to directly collect rent from tenants, conjuring up images of the Dickensian rent collector barracking tenants for late rental payments.  In the Pathfinder areas tenants have been encouraged to open bank accounts and to make rent payments by standing order, however the problem is the requirement of the tenant to have the relevant documentation to open a bank account and that a bank wants them as a customer.  Early indications from April indicate approximately six out of ten tenants pay their rent by automated standing order.

RICS comment on new figures from investment property databank

New figures on commercial property investment market from Investment Property Databank suggest that investors continue to enjoy firm returns.

The overall return on commercial property in May was 1.4% (reflecting the change in the value of buildings and the rental income received by investors), the highest figure in six months.

The equity and bond markets both delivered greater overall returns to investors in May, though over the past 12 months (which strips out some of the volatility in bond and equity markets), the commercial property sector continues to show the highest rate of returns - at 17.9% in May compared to 16.5% and 11.0% for equities and government bonds respectively.

The strong performance of the commercial property market reflects the impact of declining long term interest rates, which has made real estate attractive to individual investors. Also, institutional investors have also entered the market as portfolios look to diversify away from equities.

RICS believes that market (long-term) interest rates are now close to the bottom which will lead the market to lose some steam. As a result, we expect total returns to investors to slow to 13.4% in 2005 as a whole (compared to 18.3% in 2004) and 6.6% in 2006.

Bottom line is that commercial property market is set for much steadier performance after the spectacular growth of recent years.

Student let demand pushes up portfolio prices

The June edition of the Paragon Mortgages buy-to-let index shows a significant rise in the prices landlords have been paying for their residential investments, as property values increased by 2.8% or £4,265 over the month.

Average property values are now £156,887, compared with £137,112 in May 2004, representing a 14.4% increase over the past 12 months.

This rise is attributable in particular to an increase in activity among large-scale landlords acquiring additional student lets in advance of the new academic year starting in September.

John Heron, managing director of Paragon Mortgages, said: "We’ve seen landlords buying properties in several of the UK’s university towns, particularly in the northern half of the country. To meet the needs of student sharers, landlords typically buy larger properties with four or more bedrooms which, of course, tend to be more expensive than medium sized properties for occupation by families."

"This growth in buying activity among landlords specialising in the student market accounts for the significant rise in average property values recorded this month."

"A significant number of landlords concentrate on the student market, with many university towns and cities experiencing a shortage of decent accommodation for students. With four or five student sharers in a property, the return to the landlord can often be very attractive."

Investors located in the northern regions of the country continue to benefit from higher average total returns than those in southern parts. In Yorkshire, average returns are 56.2%, while in the North West they are 44.6%. The North and Wales have overtaken the East Midlands this month with overall returns of 33.0% and 28.2% respectively.

As well as seeing high levels of capital appreciation, eight out of ten regions saw rental incomes rise this month. The West Midlands and the North experienced the largest increases in rental incomes, reaching averages of £8,067 and £5,981 respectively. Despite this month’s increase, however, rental incomes in the North are still the lowest in the country. Across the country, average rental incomes are currently £10,534, representing an increase of 6.8% over the past year.

John Heron continues: "Over the past twelve months, rental incomes across the country have risen fairly consistently from £9,867 in May 2004 to exceed £10,500 this month. Landlords in the North West and Yorkshire have seen rental incomes rise by over 35% through the year."

As a result of the rise in property values, yields eased slightly to 6.7%. Even so, yields rose in five out of ten regions, with the biggest increase in the South West, followed by the West Midlands, East Anglia, the South East and Yorkshire. Three regions (the East Midlands, the North West and Yorkshire) continue to register yields of over 7%.

In terms of property type, terraced continue to provide the highest yield to landlords, at an average of 7.3% nationally. This compares with 6.3% for detached, 6.7% for semi-detached and 6.2% for flats. 

Rental incomes rose in three out of four property types with the largest increase for terraced properties. Rental incomes for this type of property now average £10,240.  John Heron comments: "The increase in rental incomes this month reflects strong tenant demand in most areas for the right type of property, which tends to be the modest home targeted at young professionals, key workers – and, of course, students. While unusually high seasonal activity among certain types of landlord, in particular those specialising in the student market, has pushed up average prices paid by landlords this month, buy-to-let investors continue to negotiate good deals on properties in an uncertain owner-occupier market."

CML calls for vigilance on property investment clubs
 
In the wake of the DTI's action to close several property investment clubs (PICs), and subsequent calls for further regulation to protect consumers, the Council of Mortgage Lenders has been examining the interaction between PICs and the buy-to-let sector. The CML concludes that there is very limited interaction, and that lenders have rigorous procedures in place to ensure their buy-to-let lending is robust. However, the CML has identified a number of steps that can be taken to reduce the risks posed to consumers by PICs.

PICs typically operate by encouraging potential investors to pay large sums as subscriptions for access to new build or off-plan properties (normally flats) at "discount" prices. Marketing usually concentrates on the ability to re-sell and make a short-term profit, rather than on rental income potential. This is very different from mainstream buy-to-let, where the focus is on long-term investment.

Lenders report that only 5-10% of their buy-to-let lending is secured on new-build property, and even less than this on flats, let alone flats involving a PIC. The concentration of buy-to-let lending that could therefore be making its way to PIC-induced investors is therefore tiny - undoubtedly less than 5% of total buy-to-let lending.

There have been calls in some quarters for buy-to-let lending to be regulated through the FSA to protect consumers from suffering loss as a result of speculative investment through PICs. But such lending regulation would not protect consumers from the particular problems that are involved - notably, the transparency of new-build property prices. The CML supports the potential regulation of PICs through the FSA, but this cannot be achieved through the regulation of buy-to-let lending. Instead, the focus should be on regulating the investment advice and inducements offered by PICs.

The CML has consulted with its members and is confident that lenders are alert to the activities of PICs, and that they actively discourage short-term speculative investment. CML members typically take a range of measures to ensure that their lending is responsible, including:

• Limiting their exposure in any one block of flats or development;
• Checking across different lenders for multiple applications by  individuals in certain cases;
• Requiring an independent valuation of properties;
• Internally auditing valuations at intervals to check reliability;
• Requiring a rental assessment as part of the valuation, to determine both the likely rental level and the rental prospects; and
• Undertaking credit assessment of the borrower as well as of the property.

The effectiveness of these measures can be demonstrated by the credit quality of the sector. BTL lending continues to show levels of arrears below those for residential mortgage lending as a whole.

The CML is also pursuing active discussions with the other bodies whose members have a role in ensuring that the public are not put at risk by inappropriate PIC activity. These include:

• Royal Institution of Chartered Surveyors (RICS)- to ensure that valuations on new build properties continue to be independent and rigorous;
• Home Builders Federation (HBF) and British Property Federation (BPF) to tackle the question of the transparency of new-build property prices; and
• The Law Society- to ensure that solicitors are fully aware of their obligations in relation to the disclosure of true purchase prices and discounts.

Commenting on the situation Andrew Heywood, CML Senior Policy Adviser, said, "The unfortunate activities of a number of PICs have attracted speculative investors who are distinct from the bulk of buy-to-let landlords. Research shows that most buy-to-let landlords are in the market for the long term. Buy-to-let lenders have taken a lead in ensuring that speculators and their advisers do not benefit at the expense of bona fide investors. It is now important other stakeholders in the residential property market are seen to maintain similar vigilance."

Civil considerations

Chancellor Gordon Brown will ensure that from 5 December 2005, same sex couples entering civil partnerships will have the same tax advantages, and disadvantages, as married heterosexual couples.  For example, there will be no inheritance tax (IHT) consequences for gifts between same sex couples in a civil partnership.  At present, an IHT charge can arise if the person making the gift dies within seven years.  Similarly, couples in a civil partnership will be able to gift assets to each other without a gain or loss arising under capital gains tax (CGT).

However, there are big disadvantages.  Married couples have only one principal private residence, whereas a cohabiting couple could own two properties without incurring CGT.

Mortgages for Business recommends that same sex couples would benefit from an understanding of the tax ramifications

Stamp duty land tax warning

From the 1st July, if you are completing a commercial property transaction worth over £5 million and you are using ‘arrangements’ of any kind, you have to disclose the details to the Inland Revenue under anti-avoidance rules similar to those for income tax.  Disclosure highlights scheme being used early on so the Inland Revenue can legislate if they believe tax avoidance is occurring.

Also hidden away in the various 2005 Finance Acts are a number of other stamp duty land tax changes which could affect you.  Mortgages for Business recommends getting advice on this matter especially if you are thinking of using group relief or variation of leases to reduce your burden.