Residential Investment Property.
The perilous world of residential valuation and surveying
“Buy to Let” (BTL) became the in-phrase of the dinner party scene in the early 21st century. Possibly because the old terminology of a “residential letting”, was tarnished with such matters as Regulated Tenancies, the Housing Acts and Rent Control. This new phenomenon was not shackled as there was a new tenancy regime principally of Assured Shorthold Tenancies (AST) that could command a market rent and the Landlord could get possession easily at the end of a 6 month tenancy. Therefore the Lenders felt they could lend on these in the same way as any other owner occupied property. However, a key element has not changed and that is the Housing Acts and a host of other regulatory measures.
This article shares some of the key points to highlight the need to be aware of the Housing Legislation and Regulation in connection with this growing area of tenure and therefore try and reduce the perils of undertaking residential valuations and surveys.
Categorisation for Residential letting
A stimulus for the current debate is that the RICS hasrecently produced a Guidance Note entitled – The Valuation of buy to let and HMO properties. This will beseen as the definitive document against which a valuationwill be measured if it is contested in the future, so it is a“must read”
A good point is that the categories of BTL as defined in the Red Book remain the same:
Category 1. Single unit let to a single household let on an AST
Category 2. A single residential unit let on a single AST but to individuals on a sharing basis up to a maximum of 4 individuals
Category 3. Licensable houses in multi occupation and multi units held on a separate title
It is important to note that both category 2 and 3 could be Houses in Multiple Occupation (HMO) and given the nature of such lettings it is to these that most of the Regulation and Legislation applies.
Legislative and Regulatory Matters – The Housing Health and Safety Rating System
All rented property must meet a legal standard and this was most recently defined in the Housing Act 2004, but did you know there is a plethora of other legislation and regulation that governs lettings? Its far too great to cover in one article but a signpost would be as follows – Property Management regulations, Building safety measures, water supply and drainage provisions, gas and electricity safety regulations, waste disposal, fire safety, duties on occupiers and landlords, Local Authority specific requirements in respect of room sizes and overcrowding.
As a letting agent or a valuer you need to be aware of what measures need to be in place, otherwise the property may not be capable of being let and this could have an impact upon the valuation. Get it wrong and this could lead to a civil action, but as failure to ensure the property meets safety standards could lead to a criminal prosecution and this may be more significant for Agents.
Housing Health and Safety Rating System (HHSRS) and a Local Authority has to take action if a property is subject to what is defined as a Category 1 Hazard, table 1 sets out the hazards.
|Uncombusted fuel gas
The definitions of Hazard category are related to a risk assessment of the property. So a healthy able single occupant in a property with a steep stairs and no handrail, would not be at as great a risk as a family with young children or an elderly person with a disability. However, the legislation does not just apply to occupiers, but also visitors so the assessment has to be fairly holistic.
As with any risk assessment, consideration is given to the likelihood of an occurrence. So what is the risk over the next 12 months, could it result in harm to a vulnerable member of society? Then the risk has to be related to probability. It is a 3-day course to learn how to do one of these and it will take about 2 hours on a fairly typical family home to undertake the assessment. It’s not something you can incorporate into a mortgage valuation without extra fee. What a valuer can do is identify potential hazards that are likely to result in a high level category of risk and then make them an essential repair or if in doubt ask for a specialist assessment in the same way as for an ongoing movement crack. The irony is, that in some cases the cost of doing something could be minor, such as installing a handrail to a stairs or bath. However, without such a simple measure and if there is an accident that results in injury or worse than the consequences could be significant.
These hazards apply to any property that is let and the breadth of the areas listed shows what needs to be considered when inspecting a rental property.
The Lenders imposed view
The risk associated with investing in property becomes apparent where the Landlord requires a mortgage. The Prudential Regulation Authority has imposed stress testing which will inevitably constrain the value of the loan that a lender can make. Lenders have to currently assume a minimum increase in interest rates of 2%, so in the following example:
A 2 bed, 2 bath flat in Batterse
- Value £1,020,000
- Rent £2,800 pcm (£33,600 pa)
- Borrowing requirement £500,000 (less than 50% LTV)
- Interest rate 3.5% with stress test 5.5%
- Interest Coverage Ratio (ICR) 145%
Therefore, the annual rent required for this level of loan is £39,875 pa or £3,325 pcm.
On the current rental levels the maximum loan is £433,000.
Result: The Landlord needs to find another 13% for the deposit.
Whether the lender assessment is a reasonable way of looking at an investment is questionable. The ICR is a fairly blunt way of assessing rental cover and seems to take no account of whether the property requires more or less maintenance or has other forms of additional cost. It is particularly vulnerable to voids especially if the repairs are significant as the ICR does not allow for long term lack of rent. Given this methodology the valuer needs to ensure the client is aware of matters that could destabilise such an approach. It does, however, highlight the importance of assessing the rental value correctly. It adds another dimension to assessing the yield applicable to capitalising the value and perhaps if this was done more frequently it would avoid this sort of workaround.
At least this use of an ICR reflects the difference between a property investment and a pure financial investment such as shares.
The Guidance Note focuses quite significantly on the Lender approach to valuations and this is because the ability to source a loan. It can have such an impact upon the value whether the valuation is for loan purposes or not. The production of an Inheritance Tax valuation has to refer to a market value dominated by sales subject to a mortgage.
Houses in Multiple Occupation (HMOs)
Any Surveyor contemplating undertaking a HMO valuation has to be aware of the sections covered in the Guidance. As that signposts many areas that need to be considered beyond the relatively simple single occupancy letting. The approach to be adopted here demands a separate article, this article is not intended to cover the specifics in this one, other than to say all the points mentioned also apply to HMOs, but more so.
There have been many examples recently of tragic consequences resulting from a fire in the home. It is not surprising that fire prevention and means of escape, feature highly in the Regulatory framework governing residential lettings. The taller the property then the more stringent the requirements. However, as many of the measures are concealed it is often difficult for the inspecting surveyor to detect whether the full extent of measures have been undertaken. Although the safety aspects have additional significance to let property, so potential buyers for owner occupation should not be deprived of understanding the consequences of fire risk as well.
Knowing the core principles as set out in the Approved Documents to the Building Regulations are a good starting point. Check up on “protected routes” as examples are given in those documents. Fire resistant doors are key together with appropriately constructed walls and ceilings. But, noting that the fire doors not having a self-closing device is no longer an indicator in most cases as they are not necessarily required, so it is important to check whether a door is in fact properly constructed for the conditions.
Adequate escape through windows is a tangible measure that can be assessed based on the guidance in the Approved Documents, but this obviously varies depending on the height from the ground level.
Be aware of inner rooms. One where an exit is only possible through another room as this may prevent them from being classed as a habitable room.
It is also important to consider where the exit route takes you as escaping into a back garden with high fences will only be acceptable if the area is as deep as the house is high.
Finally detection and warning provisions are changing or have changed recently with some areas requiring sprinkler systems. Upgrading a current system can also apply if someone is building an extension, so allow for additional cost.
We recently featured an article on the new requirements to deal with energy efficiency rating and the Minimum Energy Efficiency Standards (MEES), these are particularly significant for properties that are let and we would refer you to that article (click here)
This article merely signposts some of the considerations in undertaking a valuation on a property that is to be let as an investment, hopefully it will signify that a higher standard of performance is required from the valuer. The importance of this being that now the Standard is in the public domain then the valuer has to comply or risk penalty in some form of other. So a bit of guidance on what needs to be done:
- The terms of the work need to be clear and agreed with the client, which may involve some education for the client as to why the assessment of the property differs from a normal owner occupied purchase.
- The research and collection of information needs to be more thorough and those experienced in this sort of work use more complex site notes.
- Although many properties that are let trade by reference to comparable capital values, the “knowledgeable and prudent” buyer would be expected to consider that return on investment and assess it by references to risk.
- An investment valuation is the recognised method for many of these cases and recommended as one approach in the RICS Guidance.
- In your report ensure that you advise the client of the specific issues that impact up on value for a property subject to a letting and identify risks that may be pertinent for such an investment.