This is the first in our series of MMi Legal Toolkits on this occasion providing assistance for residential investors in Scotland
So what’s different about Scotland?
Quite a lot actually. The regulatory environment in Scotland is one in which the Scottish Parliament has been able to make its own imprint. The direction of travel might be similar to south of the border but the pace and the regulatory aspiration are meaningfully greater.
What does this mean in practice? There is a strict requirement of landlord registration and property registration. The charging of fees by landlords or rental agencies at the outset of a letting agreement are prohibited as are other “non-rental” payments. Deposits require to be placed with a regulated body and the release of the deposit is conducted through the body holding the deposit. There are a panoply of orders introduced to regulate health and safety concerns in respect of tenanted properties and further regulation is shortly expected to limit the period between increases in rent and as well as limitations in rental “hotspots”.
In many ways the private tenanted sector represents a fertile ground on which the Scottish Parliament can impose its preferred “Scandinavian” interpretation of the relationship between the market and regulation without any great cost to the public purse. Indeed, the penalties for breaches of this explosion of regulation can be pretty tough especially in the areas of deposits.
Many of these regulations have been introduced over the last five years or so and it is generally the case with property legislation that some time passes before the reality of the new environment is felt by its intended audience. Certain measures such as the elimination of upfront fees are quickly introduced but McVey and Murricane still encounter many transactions where landlords have not used the deposit system or taken into account the new regulations incumbent upon landlords.
So, this is the background and our toolkit would not be a great help without providing practical advice. That advice is considered against the transactions investors are most likely to encounter but the first item in our toolbox is a measurement of what is on offer.
The article is written from the point of view of a prospective purchaser but if you are a seller then it is equally valuable in highlighting the type of queries that a prospective purchaser may make.
The terminology is similar but not exactly the same to that utilised south of the border. It is easiest to think of tenanted properties in terms of their marketability and acceptability to a mainstream lender as security.
There are three variations:
Short Assured Tenancy: this is a form of tenancy where the landlord, in theory, can regain possession speedily and the tenant has very relatively few rights of tenure against the landlord or a lender to the landlord. The Short Assured Tenancy was the device utilised to free up the “buy to let” market in the late 1980s in the same way as the similarly named mechanism was utilised south of the border.
The key element to the Short Assured Tenancy is that at the end of the term of the tenancy the landlord can recover possession on providing two months’ notice. The tenant only requires to provide one month’s notice. In addition, there are strict rules as to the ability to recover possession in the event of non-payment of rent or other failure to adhere to the terms of the lease.
There is of course a “but”. While the system, on paper, seems very fluid and landlord friendly the reality is that the established litigation rules surrounding recovering possession of a property mean that a difficult tenant can play the system relatively easily. Just as the choice of a property to buy is famously governed by “location, location, location” then in a Short Assured Tenancy, landlords should be governed by “quality of tenant, quality of tenant, quality of tenant". That advice is often lost on landlords seeking the highest level of rents because the reality is that resorting to litigation is generally an acknowledgement of failure. The courts will not look at a case where there is not at least three months’ rent outstanding and there are many other devices that the recalcitrant tenant can use.
Assured Tenancy: Assured Tenancies are similar to those tenancies of the past where tenants received very substantial rights of tenure. In essence an Assured Tenancy is one that is not a Short Assured Tenancy. This places under the spotlight the problems of inadequate Short Assured Tenancy paperwork that are described later in this article. It is essential that the landlord does not lose the benefit of the Short Assured Tenancy by not following the rules attached to that process. The removal of the tenant who is an Assured Tenant is exceptionally difficult and, in respect of the tenant who adheres to the terms of the lease, just about impossible. A property which is subject to an Assured Tenancy is not marketable in the sense that mainstream lenders generally will not lend on such properties. Because of the limitation of marketability the value of the property subject to an Assured Tenancy is usually considerably diminished.
Homes in Multiple Occupation (HMO): these are not really a separate category but a subcategory of either a Short Assured Tenancy or Assured Tenancy. You can find the rules for HMO properties here. Such properties are, as the name suggests, where the property into smaller living units with shared communal facilities such as kitchens and bathrooms. There are considerable additional requirements of landlords in relation to such properties.
The properties also require further registration with local authorities and relevant planning permission. While such properties are readily marketable for those seeking income they are not regarded as good security for mainstream lenders. Specialist lenders will provide mortgages on such properties but generally not on particularly attractive terms.
Purchasing a property not currently in the tenanted sector
With interest rates at zero and unlikely to be meaningfully better for many years, the acquisition of property for onward letting is popular for many investors. Such investors will vary from those holding many properties to the individual purchaser or someone, for instance, uplifting their pension funds with a view to attracting a better return.
It is not the purpose of this toolkit to provide buying advice per se but there are a number of issues that are worth keeping a close eye upon. As with most things in life often something that can appear to be too good to be true is exactly that. Here is very much a non-exhaustive list:
Properties (and particularly ex-local authority properties) which form part of a larger unit and repairs:
Because of post-war circumstances Scotland has a disproportionately high number of properties that were acquired from local authorities under the right to buy legislation which commenced in the early 1980s. Many of these properties form part of larger units from high-rise blocks to the typical Scottish “four in a block". The state of repair of such properties and the ownership of the remaining houses in the “block” are important.
It is Landlord Economics 101 that the requirement of repairs to be carried out in the future will reduce the income flow from the property and that such reduced income flow should be taken into account when considering the price of the property. However, many landlords (even those who are fairly experienced) tend to be blindsided by an apparently attractive yield. The belief that the requirement for future repairs will be able to be put off indefinitely often ignores three hidden perils. The first of those perils is whether any of the other properties in the block remain within the ownership of the Local Authority or housing association; it is normally the case that the small print within the titles will entitle the local authority or housing association an enhanced role in agreeing or organising repairs to a property even where they do not control a majority of the relevant properties.
Golden Rule 1: ascertain who owns the other properties in the block!
Where there are communal repairs individual owners and, on occasion, landlords who hold very few properties may receive some form of grant finance. Professional landlords are highly unlikely to receive the benefit of grant finance.
Golden Rule 2: do your homework to ascertain whether the property is likely to be impacted by communal works.
Where repairs are necessary local authorities or housing associations can utilise a wide variety of statutory notices or common repair schemes effectively blighting the property until the relevant repairs are carried out. If a property is likely to be subject to a statutory notice, considerable caution should be taken in either securing a contractual arrangement with the seller or negotiating a price reduction or retention.
Golden Rule 3: if there are statutory notices or common repair schemes, not only will there be a potential impact on return but a much higher likelihood of voids.
Repairs that will be necessary to conform with Scottish Government regulation:The burgeoning rulebook imposed by the Scottish Government in respect of private renting has already been mentioned and before making an offer for an attractively priced property always remember the works that will be necessary to comply with regulation. Review the detail of the property against the requirements of the regulation to ensure that you fully price in the necessary works.
Does the property fall within the Houses in Multiple Occupancy requirements:The rules for HMO properties are far tougher than for other properties. In particular the standards required for hygiene, fire and other safety are meaningful and more likely to be policed than within the “standard” rental sector. Obtaining finance for HMO properties can also be much more difficult than for “standard” rental units.
Mention has already been made of the increased legislation and regulation over recent years which has impacted upon the private rented sector. Accordingly, it is possible to construct a checklist that the prospective purchaser should consider. The importance of this checklist is even greater if loan finance is involved. Sellers should look at this checklist to ascertain whether the property which they are selling conforms. As has been alluded to many of these requirements have not immediately been followed by all landlords but there is no doubt that there is a major push for landlords to “get their act together”. Here is the checklist which should be seen as separate and in addition to the issues described in the previous section on buying a property:
- Is the current landlord registered with the local authority.
- Has the property been registered with the local authority.
- Does the property accord with the recently updated fire and other regulations relating to tenanted properties.
- If the property is being bought with the benefit of an existing tenant has that tenant’s lease been properly constituted; a form called an AT5 must be served on the tenant prior to that tenant signing a lease. The lease should be in a modern form clearly outlining the tenant’s rights and obligations. The standard of paperwork of a large number of landlords is truly appalling and time and time again these documents constituting the lease do not exist, have been dealt with incorrectly or not in the right order.
- Is there evidence that the tenant is up to date on both payment of rent and adherence with lease condition.
- Has the tenant served a notice on the landlord (or vice versa) to bring the short assured tenancy to a termination.