Communities and Local Government CommitteeWritten evidence submitted by the Council of Mortgage Lenders

Introduction

1. The CML is the representative trade body for the first charge residential mortgage lending industry, which includes banks, building societies and specialist lenders. Our 108 members currently hold around 95% of the assets of the UK mortgage market.

2. We welcome the opportunity to input into the Communities and Local Government Committee’s inquiry into the private rented sector (PRS). Our members’ mortgage finance activity reflects the evolving tenure mix prevalent in the UK. In addition to lending for home-ownership, our members also lend to support the social housing and private rental markets.

3. Our response is framed by the realities and aspirations for the PRS, and particularly those aspects that are of most significance to our members’ mortgage lending activities.

Executive Summary

4. The PRS is playing an increasingly important role in today’s housing market. It offers flexibility and choice for those households that are either unable to access homeownership or preferring to rent.

5. It is vital that, in an effort to address perceived or actual imbalances in the PRS, any government interventions must:

ensure ongoing stability of this important form of tenure;

focus on the need for increased supply in the PRS and other tenures;

be attractive to both institutional and private investors; and

be reflective of the fact that the PRS is inter-connected, where piecemeal solutions are likely to prove ineffective.

6. Our written evidence touches upon several areas in more detail.

Security of tenure. We are working with members and other bodies to best determine how security of tenure can be improved. More work is being undertaken on establishing landlord (ie lenders’ customers) demand for longer term tenancies to see whether they can be considered a more widespread, viable proposition. The effort to provide tenants with longer term tenancies should not lead to flexibilities and safeguards afforded to all parties under six to 12 month tenancies being eroded.

Regulation in respect of leasehold property. Better regulation of managing agents is needed to prevent consumer detriment where ground rents and service charges are excessive, as well as to protect mortgage lenders facing the risk of forfeiture.

Rent controls. We believe that these would be a counter-productive way of seeking to improve rent affordability in an undersupplied housing market.

General Comments and an Overview of the PRS

7. Our members’ buy-to-let (BTL) finance has both underpinned and stimulated much of the growth seen in the private rented sector over the last 10–15 years. At the end of Q3 2012, there were 1.4 million outstanding BTL loans worth £164 billion.

8. The number of households in the PRS has risen steadily since 2000, when 10% rented privately, compared to 17% in 2011. The predominant number of owner-occupiers has fallen slightly since 2007 and, over recent decades, the trend in the social rented sector has been one of slow but steady decline.1

9. The reasons for this changing dynamic are multifarious. Since the financial crisis, access to homeownership has been restricted by macro and micro-economic pressures, as well as funding and regulatory constraints on mortgage lenders. Access to social housing has become more difficult in recent years and it is widely recognised that housing supply has not kept pace with demand across all tenures.

10. Although these circumstances are squeezing more households into the PRS, the quality and flexibility offered by this sector prove attractive even where other housing options are available. Housing “careers” have become complex, with increasing numbers of people moving between tenures during their adult lives.

11. Recent CML research confirmed that UK households’ appetite for homeownership remains unabated. But for a sizeable proportion of private renters, the PRS remains their preferred tenure both in the short term (37% would prefer to remain in the PRS within the next two years) and longer term (12% in the next two years).2

12. With more households entering and remaining in the PRS, we believe there is a strong rationale for government, in conjunction with representative bodies, to build upon the strengths that this form of tenure offers and develop a more holistic PRS strategy.

Investment in the PRS—Quality and Supply

13. We welcome the intentions behind the recent Montague Review, in the hope that concerted action can stimulate institutional investment in the housing market and address the fundamental problem of undersupply. However, institutional investment should not be pursued without due recognition of the role that private landlords have played in increasing both supply and quality in the PRS. Individuals have contributed greatly to the renaissance of the PRS, supported by our members’ BTL financing.

14. There is an increasing need for housing of all tenures, as a result of strong demographic pressures on household formation rates, but low levels of new build are falling well short of requirements. The credit crunch has clearly added to these difficulties, most obviously by shrinking how much mortgage finance is available and triggering the need for fiscal austerity. These pressures look set to only dissipate gradually.

15. Individual landlords are responding by building their portfolios, but they are not in a position to boost supply of rented property to match that demand. We would welcome institutional investment through build-to-let and other means, alongside tax breaks for individual landlords to further drive up quality of existing and evolving portfolios. For example, we believe there is merit in individual landlords’ tax demands, upon sale of the property, being more aligned to what a small business would pay.

16. An area where individual landlords have made a meaningful positive impact is in increasing the quality of housing in the PRS. One initiative that could further assist landlords’ efforts is the Green Deal. This could potentially be used by landlords as a way to improve their portfolio with no upfront cost and without rent increases, which would improve renters’ experiences particularly at the bottom of the market. Much of this is dependant on the Green Deal’s “golden rule” that any bill payer will not be worse off following a Green Deal installation.

17. Any policy objective to increase quality in the PRS must be reflective of the breadth of tenants housed in this sector. There is a risk that, in striving to improve quality, any standard or initiative pushes up rents at the bottom end of the scale with those tenants on lower incomes having to find alternative accommodation or, more likely, an alternative form of tenure where options may be limited.

Tenancy Lengths

18. The private rented sector has become increasingly diverse as it has grown. Although traditionally associated with more mobile sectors of the population, it now caters to a range of households on a longer-term basis.

19. Given the challenges around access to home-ownership, we have been working with our members and other representative bodies to understand what steps need to be taken to present PRS tenants with greater security, while not eroding the flexibilities that make private renting attractive. We and individual members are in the process of working to understand and overcome the practical barriers that have traditionally prevented longer term tenancies proving viable.

20. Within the past year, we have seen a range of campaigning bodies and political parties question whether the status quo of six to 12 month tenancies affords private tenants the security and stability they may require. We worked with Shelter as it developed its report3 on this topic last year. We are encouraged that Shelter’s recommendations recognise the challenges and focus on the need for better industry incentives, rather than legislative measures, to drive changes in attitudes.

21. For some time now, BTL mortgage terms and conditions have generally restricted landlords to offering assured shorthold tenancies (ASTs) of between six to 12 months. But this in itself does not impose a restriction on how long a private tenant can reside in a property. A National Landlords’ Association (NLA) study conducted in June 2012 showed that over a half (54%) of tenancies now last between two and three years, and that almost a third (32%) last in excess of four years.4

22. Arguably the biggest barrier to longer term tenancies proving viable for lenders is the apparent lack of apparent demand from their existing and potential BTL landlord customers. A recent NLA landlord panel survey (Q3 2011) showed that only 6% of landlords were definitely interested in offering longer tenancies. It is difficult for any commercial operation to build a viable proposition for such a small cohort of customers, particularly as those that have expressed an interest will have only done so in an indicative way and without full knowledge of what might be lost as well gained.

23. Landlord demand for longer term tenancies could be regarded as running counter cyclical to both market conditions and tenant demand. We believe that landlord demand is more likely to materialise at a time of lower demand in the PRS and higher void periods, as opposed to today’s relatively buoyant rental market.

24. But, even in the absence of strongly articulated landlord demand, we have been exploring with our members whether mortgage terms and conditions could be relaxed in order to permit longer term tenancies.

25. A key challenge for lenders, and indeed landlords, to address is the impact of rent arrears where a tenant is on a longer term tenancy. The NLA study in June 2012 showed that 49% of landlords experienced rent arrears within the last year. Higher mortgage arrears could potentially result and a lender’s ability to obtain vacant possession could be impeded. From a mortgage lender’s perspective, a longer term tenancy may only be a suitable option for experienced BTL landlords. And there will always be substantial groups of private tenants for whom shorter, more flexible terms are desirable.

26. Most importantly, there is a risk that a longer term tenancy may not provide landlords or tenants the same level of flexibility offered by the common six to 12 month ASTs. For example, tenants may find themselves less able to move if their personal desires or circumstances changed. Similarly, by agreeing to a longer tenancy, landlords may find it harder to flex their portfolio in response to market conditions or their own business models. The extent to which these flexibilities are retained or eroded under any longer term tenancy model will require careful consideration. Particular break clauses, over and above what is in a standard six to 12 month AST may therefore be required.

27. An effective, transparent and fair way of increasing rents, that is suitably attractive to landlords and tenants, would also need to be established for longer term tenancies to prove viable. This may be some form of index linked increase built into the AST, similar to what Shelter proposes in its Stable Rental Contract. But this would need to strike a balance between satisfying landlords’ expectations over future yields while also appealing to tenants. Without this balance being struck, a less desirable alternative would be for any projected rent increases in future years to be spread out over the life of the tenancy, which would see the tenant paying more in the first year than they might otherwise on a six to 12 month agreement.

Regulation—Leasehold

28. One area that may not be touched upon by other contributors—given how the Committee’s topics focus on agents, landlords and HMOs—is the much needed regulation of managing agents for leasehold properties. This extends beyond the realms of the PRS.

29. Our members and their leasehold customers continue to suffer detriment where a leasehold customer is in dispute with a managing agent over ground rent or service charge and, under threat of forfeiture of the lease, the mortgage lender steps in to pay the sum and protect the security. Given the relative speed and ease with which a freeholder or its appointed agent can terminate a lease, the lender may not have suitable opportunity to challenge the sums payable.

30. This is an area of increasing importance to our members and we have anecdotal evidence to suggest that: some ground rents are far from nominal and escalate in future years; and service charges can be excessive (eg the managing agent recovering legal fees through inflated ground rents and service charges).

31. In lieu of firmer regulation, there may be a considerable level of uncovered consumer detriment, where a leaseholder is unwittingly paying unjustifiable ground rents and service charges.

32. We would urge that self-regulation of managing agents is either strengthened significantly or replaced by a more independent regime and that the main method of challenging leasehold disputes, through the Leasehold Valuation Tribunal, is simplified to aid both personal and corporate claimants.

Local Authorities’ Homelessness Duty

33. We understand the pressures that led to local authorities being able to discharge their homelessness duty by placing homeless households in private accommodation. However, this solution not only fails to resolve the underlying lack of housing supply, but also has some unintended consequences.

34. Although BTL lending is unregulated, this does not diminish our members’ desire to lend responsibly. When assessing risk at a policy level, individual lenders will need to determine, for example, whether properties tenanted by housing benefit claimants increase the likelihood of the landlord falling into arrears. There are a number of factors that will play into this.

35. There is inherent risk where housing costs will be paid to the tenant, rather than the landlord—increasing the potential for that money to be used for other purposes. Inexperienced or smaller scale landlords may find it particularly difficult to managing the tenant and secure the rental income.

36. The lack of “skin in the game” that benefit-claiming tenants have, particularly regarding negotiating rents, can lead to higher refurbishment costs for the landlord. Those higher overall costs are unlikely to be subsidised by higher rents given recent decisions to cap housing costs under the Universal Credit. Such dilapidations can impact on the lender’s security.

37. It is for these reasons that some lenders take the view that the risks are too high and impose a restriction in the BTL mortgage terms and conditions prohibiting a customer from letting to a housing benefit claimant. Not all lenders impose these restrictions and, even where they do, some are willing to accept benefit tenants through “private lease schemes”, whereby a local authority enters into agreement with a private landlord (usually on a longer term lease of two to five years) with rental payments guaranteed by the local authority.

38. But, looking forward, there is a risk that landlords are less likely to let to benefit-claiming tenants given the proposed welfare reforms being brought about by the Universal Credit. With the Local Housing Allowance being brought within the scope of Universal Credit, landlords may find it more viable in a high-demand rental market to source alternative private tenants. A recent survey undertaken by the NLA revealed that 96% of landlords were concerned about the introduction of the Universal Credit.5 In a similar vein, those lenders that do impose risk-based restrictions on benefit-claiming tenants are likely to need the impacts of Universal Credit to bed-in before considering any change in policy.

Rent Controls

39. The recent pattern of steadily increasing private rents6 is a manifestation of supply not keeping pace with demand. Any solutions designed to suppress rising rents should therefore be aimed at addressing the root cause, rather than introducing artificial and ineffectual strictures such as rent controls.

40. The growth of the PRS was facilitated by the deregulation of the sector in the late 1980s, which led to investment funded in part by BTL finance. Imposing rent controls would dissuade this type of individual, and most likely institutional, investment on which the PRS is built. Both the quantity and quality of housing supply would suffer as a result.

41. Investment and housing quality would also suffer given the likely squeeze on yields. Recent studies by the Greater London Assembly7 and the Joseph Rowntree Foundation8 support that view. It is also important to note that yields in London are below the UK average despite rents being the highest of any UK region.9 As the Mayor of London’s recent consultation on a Housing Covenant for the PRS recognised, rent controls in the capital would not be the answer to rent affordability issues.

42. In addition, comparisons between high rents and average mortgage payments should not be taken at face value. A more detailed analysis that we published in early 2012 (which mapped Valuations Office Agency data on average rents against our own Regulated Mortgage Survey data) showed that there is no evidence to suggest that renting has become universally cheaper than buying.10 Indeed, when deposits and other factors are taken into account, renting may prove cheaper. And tenure choices are driven by many factors, including maintenance and repair costs and the risk of negative equity that comes with being an owner-occupier.

January 2013