New Government White Paper: A Fairer Private Rented Sector

Further to the election commitments and consultations undertaken by the current UK Government, on 16 June 2022 a White Paper was published as a precursor to the Renters Reform Bill which is planned to come forward in the current third Parliamentary session (specific dates yet to be confirmed).

In this article we will look at the proposed reforms as they impact on the terms of tenancy agreements relevant to the professional PRS market. The key point to keep in mind at this stage is that there is no draft legislation available yet, so we can only speculate as to much of the relevant detail. We are maintaining a watching brief and will provide updates on the points set out in the White Paper as they are announced.

A 12-point plan of action

The White paper details a 12-point plan of action which sets out the government’s commitment to ‘robust and comprehensive changes to create a Private Rented Sector that meets the needs of the diverse tenants and landlords who live and work within it’. Points 3 (abolition of section 21 ‘no fault’ evictions) and 5 (rent review) are key provisions for the professional PRS market.

Media attention and Government announcements are particularly focused on the “no-fault evictions” aspect of the proposals, citing examples of poor practice where tenants have been badly treated. Like a lot of UK legislation which seeks to regulate an otherwise free market, the general intention is to protect consumers from poor practices - the danger being that in so doing the new regulations are also being imposed on those professional organisations that do not behave badly but could nevertheless be adversely impacted. Clearly the Government’s stated intention is to both improve investment to increase amount and quality of the housing stock and regulate so there is a careful balance that needs to be struck here.

A number of these proposals are particularly more favourable for tenants that are dealing with the less professional end of the PRS market where quality of the premises tends to be less and some of the reported behaviours are notorious. Accordingly, if the individual buy-to-let segment becomes less favourable then there is an opportunity for the professional/institutional market to attract additional tenants. We could see a similar shift to that which was seen in the student accommodation market where there has been a significant increase in purpose-built student accommodation (PBSA) and reduction in the individual private landlord market. Arguably that was at least partly driven by better (more stringent) regulation which was more costly to comply with and so reduced the stock of the private/individual student landlord market making way for improved demand for PBSA.

Of course, press releases and media commentary tends to overly generalise. As mentioned above, what has been produced now (on 16 June) is a White Paper and not legislation. There are some very clear signals as to the proposed new legislation but there is also a lot either not said or left ambiguous. In relation to the so-called ban on no fault evictions and ban on rent reviews, yes there will be a material change but these are not complete bans – there will be a number of exceptions. We have sought to provide a summary of the key proposals and give a view on where there might be some appropriate protections for the investment market and avoid stifling an increase and improvement in the UK’s rental housing stock.

Below we focus on:

• the abolition of the section 21 “no fault�� evictions;
• the proposed new tenancy structure and some specific terms pertinent to PRS;
• rent review arrangements.

Assured Shorthold Tenancies (ASTs) will be changed to periodic tenancies

Why?

The White Paper states that the purpose of this change is (a) to provide greater security for tenants while retaining the important flexibility that PRS offers; (b) it will enable tenants to leave poor quality properties without remaining liable for rent or to move easily when their circumstances change.

Tenants will have to provide a minimum of 2 months’ notice to end the tenancy to “ensure landlords recoup the cost of finding a tenant and avoid lengthy void periods”.

There is no reference to a minimum term being permitted. Ordinarily a periodic tenancy has no minimum term – it is a rolling term (usually by reference to the frequency of rent payments eg if rent is payable monthly then the term would be monthly). It is worth noting that the White Paper refers to some key features of a periodic tenancy in the current market as Government sees it, namely, no fixed term, rent is payable up to the end of the notice period (“typically one month but can vary”) and a landlord can terminate on 2 months’ notice (using section 21).

Another feature of the tenancy term to which the White Paper refers is that landlords should be able to regain possession efficiently “when they have a valid reason to do so”.

The overall message appears to signal the following changes:

• A minimum fixed term will not be permitted (beyond the 2 month tenant break option). However, it is worth noting that there is an “FAQ” document which was published by Government at the time of the consultation that preceded the White Paper. This has a seemingly contradictory reference to the possibility of still having a fixed term tenancy. It notes that when section 21 is abolished, all relevant tenancies will then be “assured” tenancies and that “[t]his would mean that landlords and tenants could agree a tenancy agreement to suit them – either covering a fixed term and/or a periodic contract…”.
• It is possible that tenants will have to demonstrate that they have met certain criteria in order to use their 2 month termination notice: have their “life circumstances” changed or are they “unhappy with the property”? Given these are nebulous concepts we think it is unlikely that these will have to apply but we can see an argument (to lend some support to the landlord) that these may need to be demonstrated to break “early” (eg within the first 6-12 months).
• The Government is seeking to allow tenants to keep their home (and allow some security of tenure) and so they need to remove the landlord’s ability to use the no-fault section 21 termination procedure; and allow tenants to also have flexibility to move on ie allow them to terminate on 2 months’ notice (possibly without a minimum term) – creating, Government says, a “level playing field”. For a professional PRS landlord, the ability to remove a tenant without cause (no fault) allows a method of improving the passing rent following the fixed period instead of imposing a rent review mechanism in the tenancy. Currently, for a 6-12 month AST, after that initial fixed term there is then a periodic tenancy and if the landlord and tenant cannot agree the rent and other terms for a new tenancy the landlord could use section 21 to bring the tenancy to an end. Likewise the tenant can serve notice and move on (for any reason) after the fixed term.
• Landlords are to be provided with a more efficient system of regaining possession from tenants who do not comply with their obligations and in some other limited circumstances (unlikely to apply to the professional PRS market).

Sales and redevelopment

The ban on non-fault evictions is subject to some exceptions, including sales and redevelopment:

• The tenancy can be brought to an end by the landlord if it wishes to sell the property, more specifically, Government have stated that:
  • “The landlord will need to demonstrate they intend to sell the property. It cannot be used within the first 6 months of a new tenancy unless [for a CPO]. We will prevent the original landlord marketing and reletting the property for 3 months following the use of this ground.” Two months’ notice of the intention to sell needs to be given under this ground.
  • We assume the above marketing freeze condition only relates to a new letting (as opposed to marketing for sale). There is no reference to what will be the consequence of breaching the marketing freeze condition will be or how it will be policed.
• The tenancy can also be brought to an end on 2 months’ notice (but not within the first 6 months) if the landlord wishes to “demolish or substantially redevelop”. The landlord will need to demonstrate that they intend to demolish “or make substantial changes to the property that cannot be undertaken with the tenant living in the property”. Let’s see how closely this might follow the regime that applies to the commercial real estate sector with the use of ground (f) under the 1954 Act. Will stripping out and replacing the kitchen and/or bathrooms over, say, a 1 month period be sufficient grounds? What if the tenant volunteers to vacate for the temporary period instead of giving up the tenancy? Note the Government’s stated intention is to afford tenants greater security (of tenure) so we can see that a refurbishment may not be enough.
• There is also a proposed ground for ending the tenancy on 2 months’ notice if suitable alternative accommodation is “available”. There is no detail on this. Perhaps it might be useful for a landlord that owns a block of flats and wishes to undertake a refurbishment programme through the building and move tenants around. What is not clear is how rental growth can be secured as part of that process.

A further parallel with how the redevelopment grounds for commercial real estate can be difficult in practice under the 1954 Act, in a multi-let building there can be difficulties for a landlord proving redevelopment grounds where one tenant might be reluctant to move (either for genuine or tactical reasons). Managing a vacant possession strategy to enable a substantial refurbishment could be more difficult to navigate for a landlord of a block of flats under the proposed new regime with the unintended consequence of reducing investment in upgrading the quality of those homes. The Government (and others lobbying for change) are understandably focused on improving the position in relation to properties in the poorest condition, they do need to make this workable for investors that want to turn average quality housing into good quality housing.

Rent reviews

So if a tenant can walk-away after 2 months (assume for any reason) but the landlord has no ability to bring the lease to an end, what will happen with rent review mechanisms?

Of course, with the new periodic tenancy regime and the tenant’s ability to terminate after 2 months, the landlord is left exposed (in a shorter period than it would be if it was within a fixed term) to reducing rents in a falling market if tenants choose (for whatever reason) to leave the property. However, for a professional PRS property (ie multiple units in a block and/or across a portfolio), there will be a continuous churn of tenants and query whether there would be a significant impact on valuation moving from, say, a 6 month minimum term to a 2 month minimum term? Valuers will surely be more influenced by the quality of the “product” (including the operations) rather than how long any particular tenant is “locked in” to a fixed term?

Another factor that should give comfort to landlords is that most tenants are unlikely to want the inconvenience and costs of moving out quickly (within what would have been a typical 6-12 month fixed term) – unless of course there is a good reason to do so because of poor quality accommodation.

The White Paper deals with rent reviews within the section on “improved dispute resolution” (which may be informative of how rent review mechanism are seen ie an area of dispute). The key features of the new proposals are as follows:

• Rent increases to be applied up to a maximum of one per year within a minimum of 2 months’ notice from the landlord (this clearly ties in within the 2 month termination notice of the tenant).
• They will “end the use of rent review clauses” (importantly, this does not mean that rent cannot “change” during the tenancy but does mean tenants cannot be “locked into automatic rent increases that are vague or may not reflect changes in the market price”). Of course, if the contractual terms of the lease required a rent review to a level the relevant tenant does not like, they can walk-away after 2 months. What the Government appears to be seeking to do is prevent the tenant feeling that they have no choice but to walk-away because of a “high” rent increase.
• Improve tenant’s ability to challenge “excessive” rent increases.

Related to the above there are some important phrases used in the White Paper, namely:

• “Unexpected” rent increases have an adverse impact on tenants (likewise they recognise the issue of voids for landlords).
• There is no support for rent controls to set the level of rent agreed at the outset of the tenancy (in other words, rent will not be limited to the day-one amount).
• Rent “adjustments” (or changes) should be predictable and allow time for tenants to consider their options.
• Rent paid in advance (eg if a landlord required 6 months rent paid in advance) will have to be repaid if then tenant terminates early (however, for this to be a point then there would need to an initial fixed term. This is another contradictory feature of the materials issued by Government on these proposals).

So, the signals from the White Paper are that rent reviews (arrangements to increase rent that are “vague”) will be banned; fixed rent increases will also be banned; but rent can be changed if they can be tied to something which is predictable and/or reflects market changes. This may mean that inflation linked rent changes could be used or an open market rent review – in both cases similar to those used in commercial leases). Of course, whether one considers inflation linking to be something which is “predictable” and an open market rent as being something which (to a tenant) is not vague, is arguable. At this stage we can only speculate as to whether or not the legislation will go as far as prescribing what is or is not permitted (eg will it specifically sanction inflation linked changes) and whether there will remain some flexibility (eg a review to the higher of inflation and open market).

All rent adjustments during a tenancy will need to be undertaken through the “section 13” process. This will be unfamiliar territory for those landlords not using rent review mechanisms in their model ASTs. The current Section 13 process will surely need to be changed as part of the new legislation because it does not currently apply where there is a rent review mechanism already set out in the tenancy agreement – whereas the White Paper seems to leave open the possibility of having a rent adjustment mechanism (provided that it is not vague etc.). Essentially, Section 13 is a formal notice procedure between the landlord and tenant which can be used (in certain circumstances) where the parties cannot agree the rent. The tenant can refer the rent review dispute to the First Tier Tribunal. Currently the tenant risks that tribunal deciding that the rent should be higher than the landlord has offered but that threat is to be removed as part of the new legislation.

Other terms and the “positive renting experience”

• A blanket ban on renting to families with children or to tenants in receipt of benefits will be made illegal (for which we take it to mean there will be criminal sanctions imposed on such arrangements).
• Tenants will be allowed to have pets in their homes, with landlords not being able to unreasonably withhold consent (subject to there being pet insurance in place).
• Landlords will be “encouraged” to allow to make alterations etc (eg redecoration, picture hanging and appliance changes), subject to reinstatement requirements. The word “encouraged” suggests the legislation will be relatively light touch in this area.
• Deposit arrangements are, for now, being left to the market to continue to come up with new solutions eg insurance.

Market segmentation and other features

Will there be a financial threshold applied to some of these proposals? There is no reference to this in the White Paper but there is precedent for there to be a financial threshold in our current system and is a way of distinguishing between the larger professional / institutional market and the (generally) less reputable individual buy-to-let market.

As noted above, this may drive further change in the market by reducing the attractiveness of the individual buy-to-let and, thereby, increasing demand for the purpose built and/or larger scale, institutional / professional part of the market.

Looking largely to the future, there is also a proposed additional ground for a landlord to bring these new periodic tenancies to an end on a no-fault/without cause basis, namely, if the property is to be sold. This we see as being useful for situations where residential property is currently being used as a PRS arrangement but where the business plan is changed to now sell the property. We have seen a number of bulk purchase transactions in the market where build-to-sell units have been acquired to run as for-rent units, at least in the short term with a view to them becoming for-sale again. Gaining vacant possession to be able to implement that change of plan will be important for those landlords (and their lenders).

From a lender’s perspective, if lending on a PRS investment, there may be a view that if the landlord/borrower’s business plan does not work out then their fall back is to sell the units then the above no-fault mechanism to obtain vacant possession will be a key consideration. More specially for lenders there will also be a be a right to bring a tenancy to end on 2 months’ notice if the property has been “repossessed” by a “mortgage lender”. We are yet to see if that caters for the various different enforcement regimes that are used (ie beyond the individual residential mortgage lending market practices).

There is no reference to distinguishing between tenancy agreements with individuals and those with companies (or similar). There are some important differences in the current law but we are yet to see if Government will cater for those in the new legislation. However, in a related point there is a very clear statement that structuring around / avoiding the new legislation will not be tolerated – so expect some potentially difficult anti-avoidance provisions. Successive UK governments do not have a great track record on maintaining clarity whilst trying to legislate against avoidance mechanisms. We’ve seen this appear in relation to authorised guarantee agreements when privity of contract for leases was brought to an end under the Landlord and Tenant (Covenants) Act 1995 and we have seen the current Government’s rushed attempt to prevent avoidance of legislation, yet fail to close all loopholes with the Economic Crime (Transparency and Enforcement) Act 2022.

Similarly, there is a lack of information at this stage as to the consequences of not complying with the new legislation. Current housing legislation has provisions where the consequence of not following the law range from being entirely inconsequential (in practice) to draconian (introducing criminal offences). We have also seen plenty of evidence of these consequences being ignored by a complete absence of prosecution. The White Paper does signpost an intention to improve the compliance regime (only that will force improvement at the worse end of the market) but we can only hope this does not create an unduly burdensome overhead for professional landlords.

There will be a transition to this new legislation and it will not be retrospective. As with any material regulatory change it will be interesting to see if some landlords voluntarily move to fall into line with these proposals, or the spirit of them, ahead of time and seek to gain some commercial advantage in so doing.