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Property Auctions - Types Of Tenancies - Howard Gooddie

My apologies to all those PAN readers who have missed a chance to read and absorb their monthly 'fix' from my articles. Firstly, I decided to take a brief holiday and went and enjoyed the Scottish Highlands and the ancient history and scenery of the Orkneys and Shetlands. I have been able to tell everyone on my return how superb the holiday was, and how particularly it was improved by the fact that the renowned Scottish midges could not find their way through the mist; I returned without a single bite! Just as I was catching up momentum from my slow-down whilst I was away, my PA, trusty critic and scribe, was called away for an emergency visit to an establishment of comfort and succour and major attention from the medical profession. My next blow was to receive a call on the London train early in the morning to tell me how my staff had turned up to work and found all of our offices totally uninhabitable because of a serious major fire in the large warehouse which adjoined our offices. Very, very luckily, the Greater Manchester Fire Brigade were able to prevent the flames spreading into our accommodation, but the heat played havoc with everything and the fumes, smoke and dirt made them impossible to occupy. If you ever think of making an unplanned upheaval of the whole of your office, don't even consider it, unless it is provoked by force majeure! Do not even try to imagine the shock to staff morale as you have to move everything and then try to exist in temporary offices, cut off from all the comforts of modern telecommunication for two days. Don't even try. Incidentally, the fire was on a Wednesday night and our next auction was on the following Tuesday. My auctions co-ordinator performed miracles, and the interest and prices were so good that our buyers must have been sympathetic. I sold another 'Lord of the Manor', for a very good price - �7,750 + VAT. I feel it reflected the fact that it related to a local district in mid-Lancashire; there was noticeable local interest. An entrepreneur from the vicinity was the lucky buyer.

Enough of my reminiscences. I was provoked only the other day by a notice which we have in our brochure month by month about domestic tenancies which reads: "Intending purchasers are advised to check documentation and take advice upon the exact nature of domestic tenancies in which they are interested. Tenants who occupy on assured or regulated tenancies almost undoubtedly have their security of tenure protected. Others on Assured Shorthold Tenancies will only have limited protection."

My provocation was increased when Peter told me of three recent letters which he had received from readers asking for an item on the difference between regulated, assured and shorthold tenancies in domestic accommodation, and the nuances of the market in relation to them.

The original regulation of domestic rents started in 1914 when the government felt that they needed to protect the security of tenure and the level of rents of wartime workers. Before the First World War, landlords had been able to terminate domestic tenancies with appropriate notice. I have been told how my grandfather, who was an entrepreneur like so many of us, used to buy rows of tenanted property at auction. He was in a consortium of four people during the period up to 1914. His consortium would empty the properties, redecorate and refurbish them, and then re-let them - it was said - at sixpence a week more. (To those of you now inured to metric currency, that is less than 3p today). Having increased the rent roll, hopefully improved the quality of the covenants of the tenants, and certainly having improved the quality of the properties, the consortium would then hope to sell them on at profit - not generally by auction. The quality of the tenancies and of their relations and relatives that are still in occupation today is a testament to his skill at choosing his tenants. One of my early memories is of going rent-collecting on a bicycle, calling on some of those streets that my grandfather - much more comfortably - took in his pony and trap! The old (badly) written, leather-bound ledger detailing his transactions still occupies a treasured place in my office drawer. That, above all, survived the fire without damage.

But I digress. My article approximately twelve months ago provided one paragraph about regulated, assured and assured shorthold tenancies, and in view of all the queries we have been getting at PAN I felt I ought to cover these in more detail and bring you up to date on the position buyers at auction appear to be taking at the moment on the different categories of the investment.

All my comments this month refer to tenancies of domestic properties. The oldest category is that of regulated tenancies, which are also known as protected tenancies, and they are a successor to controlled tenancies. They only apply to a dwelling house let as a separate dwelling, and the premises must not be part of a building in which the landlord resides other than in a purpose-built block of flats. They must not be part of a larger holding of land, and they must not be part of an agricultural holding.

The length of the tenancy is not material. The Rent Act 1977 provides for certain categories of exempt landlord and indicates that the dwelling has to be occupied personally as a residence by the tenant. A company cannot acquire rights.

This type of tenancy is the oldest, and it can normally only have been created before 15th January 1989 or it was granted after that date to someone who was a protected tenant or a statutory tenant on that date. The position of statutory tenants is very important to a property investor. A statutory tenant is one who occupied on a regulated tenancy which has expired, or where a notice to quit has been issued at some time in the past. On the death of a statutory tenant the tenancy can be passed on to another relative on two separate occasions where the original person died before 15th January 1989. The person to whom the tenancy is transmitted must have been either (a) a spouse or (b) a member of the tenant's close family residing with the tenant at the time of his or her death and for the previous six months. Where the tenant or the first successor died after 15th January 1989 the tenancy can only be transmitted once and the successor then holds an assured tenancy, which I shall detail later.

Regulated tenancy - can arise if they are created after 15th January 1989, if they are a tenancy granted as "suitable alternative accommodation" after a possession order, and if the court considers a regulated tenancy more suitable than an assured tenancy of the alternative accommodation provided. There are other factors: a regulated tenancy cannot exist if the rent includes payment of board and attendance; the premises must be let as a separate accommodation with no living accommodation shared; it must not be a business tenancy, even where dwelling accommodation is involved; and the property must not have an on-licence for liquor. There are certain grounds for obtaining possession, but a court order is always needed and both the mandatory and discretionary grounds are very stringently treated in the courts.

The rent of properties on regulated tenancies cannot be increased, other than by an application to and a decision by the Rent Officer. This is the "fair rents" procedure, whereby the landlord can apply to have the registered rent increased every two years. The government endeavoured to cap these increases to 10% of the existing rent, but in a recent court case it has been decided that Parliament exceeded its powers in so doing. It is understood they are currently considering an appeal.

"Fair rents" are anything but fair to landlords. The Rent Officer has to assume that the demand for properties in the district is exactly equal to the number of properties that are available, and has to have regard to the level of existing rents in the area before reducing the rental figure to eliminate any "scarcity value". Many registered rents are currently settled at between 60% and 80% of open market rental value. There is an opportunity to appeal to a Rent Assessment Committee.

What does the investor look for in properties let on regulated rents? They are generally readily saleable, and it is very seldom in any sale room that a property let on a regulated tenancy does not sell. In recent years, the demand has diminished a little, mainly because the rate of inflation has been stabilised at a relatively low figure and the vacant possession values of houses have not been escalating as quickly as they were, say, ten years ago. The average rate at which houses let on regulated tenancies come empty is about one-in-six per year, and investors relied on this for capital gains (particularly in the years when they were not taxable) once vacant possession was obtained. A lucky buyer might be able to buy at between 50% and 55% of vacant possession value, where a property is occupied by a regulated tenancy, but as the stock of houses reduces, the rents increase, the stock tends to be a little more modern than it was, and the tenants grow older, so the prices paid in the sale room have crept up to between 60% and 80% of vacant possession value. In my view, the investor is unwise to buy at the top of that range, since it is inevitable that the houses need modernisation before they can be re-sold, and much of the potential profit can be absorbed. In my office, when we are offering properties on this type of tenancy, we frequently have potential bidders asking us the age of the tenants. Often we do not know (and are far too polite to ask aged women tenants!) but particularly it seems to be our experience that Murphy's Law and actuarial theories still support our views that older tenants frequently give up possession far less early than the younger ones.

Assured tenancy - those which are at open market rent, but where the security of tenure and rights for succession still exist. The Rent Officer's sway still has some effect on the rent that might become payable, since Housing Benefit levels - if they apply - are limited by his decision as to what is an appropriate rental level. He has to assume that the size of the premises is limited to what is appropriate for the tenant and occupiers of the house, but he does not need to deduct any "scarcity value". An assured tenancy may have come into existence on a succession of tenancy following the death of a tenant on a regulated tenancy, or where inappropriate notices were served at the beginning of a tenancy which the landlord intended to be an assured shorthold. The important result of such a failure is that the tenant has the security of tenure which he would have had if he had been a regulated tenant.

The market for properties on assured tenancies seems to be very similar to that for properties let on regulated tenancies, and the same parameters of value in relation to the vacant possession figure seem to apply. In my view, logically, such properties should be worth more since the rent on an assured tenancy is going to be higher, but in practice I suspect that many buyers are not really aware of the difference between an assured tenancy and a regulated one, and only work out their figures by looking at the potential capital gain at the time the tenant leaves. Net income return from the property does not seem to be a consideration.

Assured shorthold tenancy - provide our remaining category of residential tenancies, and broadly cover the remaining spectrum of tenancies which have been more recently created over recent years. At one time there were strict requirements for the form of notices issued to tenants at the start of assured shorthold tenancies, but these have now been removed. Any letting (unless specifically expressed to be otherwise) of a dwelling house as a separate dwelling for a term of not less than six months without power for the landlord to terminate within six months of commencement is an assured shorthold tenancy. We find therefore a greater and greater number of domestic properties that are let have been done so on assured shorthold tenancies. They are the "bread and butter" purchases of the "buy-to-let" investor who prefers to purchase with a tenant in occupation rather than buy with vacant possession and look for a tenant. Once an assured shorthold tenancy has expired, it can be terminated by two months' notice, but should the tenant resist that notice it may still be necessary to obtain a court order for possession. An assured periodic shorthold tenancy can pass to the tenant's spouse or common law spouse who survives after a death, but there are no other security rights such as those of a regulated tenancy.

In theory, therefore, any buyer should be able to look at the period remaining of any tenancy and then calculate his price based on the figure he might get for vacant possession plus any expected appreciation. However, the buyer must allow for what might be a limited yield during the period whilst he is waiting for possession, loss of rent towards the end of the lease, any costs of restoration before the sale, and the actual costs of sale. Strictly speaking, valuation theory would suggest therefore that one should not bid more than 80% of the expected vacant possession value of the property in the auction room when there is an assured shorthold tenancy.

It is, however, at this point that yields appear to matter to investors. Generally they do not appear to be looking for vacant possession and a capital gain but buying for investment. I can point to many instances in my sale room where properties of this kind can, in the poorer areas, sell for four times the gross annual income, going up as far as seven times that gross income where the property is modern and in superlative condition. In practice, many owners of properties let on assured shorthold tenancies will frequently be unwilling to sell at these sorts of figures, and the reserves tend to be higher. For some reason, most buyers seem to prefer buying properties with vacant possession, carry out their own improvements and then let houses to their choice of tenants. In my view the resulting yield is frequently likely to be less than that which could be obtained by buying a property with the tenant in situ. Presumably investors prefer to have tenants of a mould which they choose and see that the property is brought up to letting standard in their own image rather than that of others.

I wonder how these markets might move? I have referred already to the increase in values we have seen of properties let on regulated tenancies in the last two or three years. Presumably Rent Officers are likely to bring rents closer and closer to open market values as the scarcity factor diminishes.

Perhaps by then investors will be buying on the basis of yield, rather than on their view of the capital gains that can be made when they obtain vacant possession. Hopefully the whole market will move towards considering purchasing every type of residential investment on a yield basis, despite the government's recent attempt to "cap" increases of fair rents. I would hope that the housing market is now such that there will not be many political moves to revert to the "old days" of the four "r's" - registered, regulated and restricted rents. Only by moving away from the old-fashioned political ideas on protecting tenants can we expect to see the continuing increase in flexibility and expansion of the residential investment market.

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