The private rented sector has seen rapid growth in the last decade and the trend is set to continue as ownership becomes even more elusive for those not yet on the housing ladder. As a result, and as low interest rates continue to stimulate appetites for borrowing (at least at the moment), investor demand is strong (despite the government's recent activities in the sector) and BTL lending is on the rise. The RICS' guidance note on the subject of BTL/HMO valuation is therefore essential reading for all practicing in this space; but will it prove to be a stick which professionals may ultimately be beaten with?
The PRS is now the second largest sector of housing tenure in the UK, having overtaken the social housing sector for the first time since the 1960s. Projections suggest considerable growth in the PRS sector in the next 10 years and this is despite recent attempts by the government to put the brakes on – with SDLT / reductions in landlord tax relief already introduced, letting agent fee bans looming and most recently a real shakeup in the lettings/management sector seemingly on the horizon.
As the claims from this part of the housing sector after the credit crunch bear testimony, valuing such properties created challenges for valuers and the recent RICS Guidance note aims to address this.
The status of Guidance Notes is such that adherence is not mandatory, but in the event of a claim, it provides a useful defence to show that the valuer has acted in accordance with it. On the flip side, it raises the expectations of benchmarks for lenders who are commissioning and relying on these valuations and cynically, non-compliance provides potential claimants with a means of criticising the valuer. The Guidance Note looks to arm valuers with everything they need to know about valuing buy-to-let properties and we set out below some of the key points.
Categories of property
There are 3 categories of buy-to-let (BTL) property covered by the Guidance Note:
- Single residential units - Individual houses or flats let as single households. These are the most common form of BTL property and a straightforward valuation using comparable evidence will usually be used to arrive at a capital and rental valuation.
- Shared houses - Single individual houses or flats let to no more than four individuals that share amenities. The occupancy will be on a single AST with multiple joint tenants or multiple tenants with individual ASTs. This sort of property may therefore fall within the definition of an HMO but may not be licensable. The assumption here is that shared house can be valued on a comparable basis, but a valuer may wish to analyse comparables on an investment basis in an area where there is a high density of investment property. In either case, the valuer should comment on the rationale for the method chosen.
- Houses in Multiple Occupation (HMOs) - These can be particularly complex in terms of valuation methodology and compliance with the various regulatory and licensing requirements. The Guidance Note sets out a number of different circumstances for HMOs and guidance on valuing them. However, generally it may be possible to value an HMO using comparable evidence, but an investment valuation may be considered where the property is not directly comparable with other properties in the area. It may also be necessary to consider the extent of the works required to convert a property into an HMO when considering its value.
It is a common misconception that the private rented sector is not regulated. It is in fact heavily regulated and the licensing requirements for HMOs, in particular, are ever increasing.
The first question a valuer will need to consider is which category does the property fall into. Category 1 is easy, but then the complexities start. The Housing Act 2004 provides 5 tests to determine whether a property is an HMO. These tests essentially boil down to whether:
- An entire house/flat/converted house is let to 3 or more tenants who are not a household, but sharing amenities;
- A building which is entirely converted into self-contained flats which does not meet Building Regulations 1991 and more than a third of occupiers are on assured shorthold tenancies.
The over-arching criteria is whether the property is to be used as the tenants' main or sole residence and that they are paying rent.
In considering whether a property might be an HMO, the valuer should make enquiries as to the status of the property from the agent/owner, record what they are told or have deduced from their inspections and finally, report any assumptions and/or deductions in the valuation report in plain English. It is important for valuers to be aware of the relevant Local Authority requirements. Whilst the scope of the inspection for mortgage purposes is not sufficient to confirm full compliance with regulatory aspects, the property should display reasonable signs of conformity with the requirements.
The intention behind the Housing Act 2004 was to afford greater protection for tenants, often from vulnerable parts of society, by raising general standards and conditions of the properties themselves, as well as policing the actual management and the people involved.
There are three forms of licensing worthy of particular comment:
- Mandatory – Properties over three or more storeys, occupied by five or more people and with at least 2 separate households.
- Additional – This gives the Local Authority power to impose conditions on properties that fall outside of the mandatory regime and to address properties that are ineffectively managed to the detriment of either the tenants or the public. These powers are commonly used to address anti-social behaviour, noise or the poor quality of the accommodation offered.
- Selective - Again this is within the Local Authority's discretion and is aimed squarely at areas where there is low housing demand or significant anti-social behaviour within private sector housing.
The nature and effect of such licences are that the licence will stipulate the number of occupants and various conditions that must be complied with. Licences are not transferable, so a new owner will need to make a fresh application. It is a criminal offence not to have a licence or not to have at least made an application for one, with a potential fine of up to £20,000 plus costs.
The Local Authority can also apply for a 'Rent Repayment Order' to recover up to twelve months of any housing benefit paid. A breach of any Licence condition could also result in a fine of up to £5,000 and revocation of the Licence.
From a valuer's point of view, it is therefore worth considering the following:
- Assume a licence is necessary for all units with 5 or more people where facilities are shared and there is clearly more than one household in occupation.
- Be familiar with the Local Authority requirements in the relevant area and likely range of licensing requirements so that any obvious contraventions can be flagged.
- Flag any assumptions in the report relating to:
- Whether the property is likely to fall within a licensing regime in order that legal advisors can check that all licences are in place and that there are no known breaches that may impact on investment income.
- Whether the property is in a designated area which may also impact on investment income.
Any issues with the property may result in enforcement action by the Local Authority to restore the property to its original condition. BTL properties have often had internal works or extensions in order to create further lettable rooms. Although there is no obligation to investigate with the Local Planning Authority, it is important to note given the potential effect it would have on rental income, and thus an affordability assessment insofar as a lender is concerned.
The Guidance Note was released in November 2016 and it is therefore too early to judge whether it will result in any future increase in claims. Of course, if there is another market fall, claims against valuation surveyors will be inevitable and where it can be used to their advantage those bringing such claims can be expected to seek to use the guidance to criticise.
So yes, it is probably a double edged sword. On the one hand it is undoubtedly a great reference work for those who take the time to become fully familiar with all the complexities of BTL/HMO valuation and develop processes to minimise the risks attaching to this type of valuation. On the other, it is a potential banana skin for anyone willing to accept a BTL/HMO instruction without the necessary level of specialist knowledge to do so.
Of course, this once again brings into sharp focus the issue of Risk v Reward in the secured lending arena. There is much to know, to be alive to during the inspection and to warn/caveat the client about in the report. Finding three sufficiently similar comparables and calling it a day is no longer good enough (if it ever was). The profession needs to price their offerings in this space accordingly or risk finding, once again, that the exposures subsequently faced are wholly disproportionate to the price of the product originally provided.
Please click here to view the full RICS Guidance Note.