For those browsing the Allsop residential catalogue, you will have seen the wide-range of properties that we take to the auction room. Freehold blocks to tenanted flats, development opportunities to estates of houses. In every catalogue we also offer a small number of properties subject to regulated tenancies. These types of tenancies are, over time, becoming increasingly uncommon, but remain highly sought-after by a specialist pool of investors. But what are Regulated Tenancies and why invest in them?
What is a Regulated Tenancy?
Regulated Tenancies date back to the Rent Act 1977. This Act applies to all residential tenancies created before 15 January 1989. Any new lettings after this date are governed by the Housing Act 1988 (as amended) and are usually Assured or Assured Shorthold Tenancies (ASTs).
Importantly, Regulated Tenancies give the tenant the right and security to remain in their property for life. They usually pay a ‘Fair Rent’ set by a Rent Officer at the Valuation Office Agency. This is usually lower than a market rent for the equivalent property and can only be increased every two years through application to the Rent Officer by the landlord.
As with ASTs, it is the landlord’s responsibility to maintain the structure and exterior of the property, but the internal condition of the dwelling is largely the responsibility of the tenant.
Regulated Tenancies are an attractive prospect for some investors, as they are usually purchased at a discount to the underlying vacant possession value, due to the restrictions on rental increases and the lifetime security of the tenant. Whilst this does not suit all investors, those who are not typically yield driven, but are focused on long term capital growth, invest for the ‘windfall’ gain when possession is relinquished. After the end of a Regulated Tenancy, the property can be sold by the investor who recovers the discount that was applied at the time of purchase and, all being well, any capital value growth since the time of purchase.
However, a Regulated Tenant is permitted to pass on the tenancy to a close relative if that person has lived in the property for two years before the death of the original tenant. There is some risk therefore for the investor that the expectation of selling the vacant property could be deferred if there is a succession. In this event the rent payable by the new tenant converts to a Market Rent.
Due to the length of occupation, a landlord may find this type of tenant will have treated the property as their own home, meaning that minor repairs and cosmetic factors will, in all likelihood, have been dealt with. This generally has the effect that Regulated Tenants are less of a ‘hands on’ tenant for private landlords than an average AST. However, there is little incentive for either tenant or landlord to undertake major improvements (largely because of the low rent) so many Regulated Tenancies are quite unmodernised – particularly considering that all have been in existence since before 1989.
Implications for the Valuer
From a valuation perspective, there are a number of implications when considering Regulated Tenancies and a process to ensure that a suitable discount to vacant value is applied to attract a good level of interest from investors.
In the Allsop residential auction, lots subject to Regulated Tenancies are selling typically between about 75% and 85% of their vacant value. This demonstrates a healthy and attractive discount for investors, but whilst applying a discount to a property is a seemingly straightforward process, unfortunately, a ‘one size fits all’ approach is not always suitable when determining the discount.
One of the main drivers to determine a suitable discount is the timescale estimated before vacant possession of the property may be achieved. The valuer may have information from the landlord about the age of the tenant(s) and whether there is a possibility of succession. If so, the valuer will adjust the discount up or down for older or younger tenants. However, new data protection rules (GDPR) may mean that age information isn’t available (or alternatively cannot legally be sought) in which case an ‘average’ discount is more appropriate.
It is also interesting to note that we are seeing at auction a growing trend of much narrower discounts to vacant value where quite low value dwellings in the North of England have a Fair Rent that still delivers a highly attractive yield. We have seen Regulated Tenancies trade at more than 90% of vacant value – even at 100% of vacant value – where the resultant rental yield can be 7% gross or upwards.
Key Points for Investors
A property with a Regulated Tenant can be an attractive prospect, but as with all investments there is a degree of risk and the investor must know what they are buying.
Firstly, the buyer needs to take into consideration the implication of any succession rights on the property, as this ultimately delays when it will become vacant. However, it is of some comfort to know that a tenant who succeeds to a Regulated Tenancy will be paying a Market rather than Fair Rent.
Secondly, whilst a Regulated Tenant may have treated the property as their own home and carried out minor works, there is no financial incentive for them to spend large sums of money on a property which they do not ultimately own. As such, investors may find that properties subject to Regulated Tenancies will have dated kitchens and bathrooms, and in some cases, no central heating. A significant amount of capital expenditure may therefore be required to bring the property up to a reasonable standard before being re-let or sold.
There are fewer than 75,000 Regulated Tenancies left in the UK and all have an ageing tenant pool. Their rarity value together with improving rental levels is likely to see discounts to vacant possession narrow further in the coming years. They remain highly sought-after, not just in the auction room, but also in small portfolios by private treaty.