Longer term tenancies? Potential implications for lenders

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Walker Morris’ Banking & Finance Litigation, Collections & Recoveries and Housing Litigation experts Justin Coley and Karl Anders explain the UK government’s consultation on introducing longer-term tenancies in the private rented sector, with a particular focus on potential impacts for lenders.

Proposed new framework for residential tenancies

The government has published a consultation on ‘Overcoming Barriers to Longer Tenancies in the Private Rented Sector’.

In summary, the government believes that the current minimum 6 month assured shorthold tenancy results in tenants having to leave properties and bear the costs of moving frequently, which creates uncertainty and a negative impact on tenants’ financial situation, health and wellbeing. The government believes that this particularly affects households with children who are then also forced to move schools; it is a contributor to homelessness (as tenants find it difficult to find new affordable accommodation); it results in void costs and renewal/reletting fees for landlords; and it has a negative impact on the maintenance of individual properties and on communities.

The consultation therefore proposes a new framework for residential tenancies which would involve a minimum term of 3 years, but with a landlord and tenant break option from 6 months and a rent review to take place no more than once per year.  The proposals suggest that the tenant could break without reason on giving 2 months’ notice and the landlord could break by giving notice on any of the existing Housing Act 1988 (HA) grounds (which include tenant-fault and the need for the landlord to sell/occupy). There would be some exemptions, including student accommodation and holiday lets.

There are various known barriers to longer tenancies, which are addressed in the consultation document. One of these is the common buy-to-let mortgage condition stipulating tenancy length.  However, the government notes this only applies to the landlords who are bound by such conditions (as opposed to those who own properties outright or via some other finance arrangement); and, by June 2017, some 60% of lenders were already allowing tenancies of more than a year. Nevertheless, a very significant number of existing mortgages remain affected, and so what are the potential implications for lenders?

Potential impact on lenders

If these proposals were to be approved, one impact would be that a very significant number (1,889,200 [1]) of existing buy-to-let mortgage borrowers could be in default upon granting a new longer term tenancy.  That is because any such tenancy would be inconsistent with the existing tenancy length stipulation in the mortgage offer and conditions.

That would give rise to a right for the lender to recover possession and any possession order obtained would also be binding on the tenant. That would result in their eviction,  subject only to the limited 2 month ‘buffer’ protection provided to unauthorised tenants by the Mortgage Repossessions (Protection of Tenants etc) Act 2010 [2].

This consequence therefore potentially undermines one of the key purposes of the government’s proposals, which is to reduce the circumstances in which tenants are forced to leave properties.

In circumstances where the longer term tenancy is approved by the lender (either via a consent to let process or as a result of a mortgage offer and/or terms and conditions which permit this), what are the lenders options where a tenant is paying the rent, but the landlord/borrower nevertheless defaults on its mortgage?  In those circumstances, the tenancy is binding on the lender.

One option might be for the lender to appoint a receiver [3] who would be able to manage the property and collect rents for the benefit of the lender. Appointment of a receiver would incur some costs and it may have to be a long-term arrangement where a fixed term tenancy of a number of years is in place and the tenant is complying with the tenancy.

However, it is worth noting that the value of the lender’s security is likely to be reduced in circumstances where the property had to be repossessed and sold with a tenant in occupation under a longer 3 year tenancy, and lenders are unlikely to want receivers managing properties for such a long period. In addition, if lenders are forced to sell with tenants in occupation, that calls into question how they will value properties when considering the loan-to-value ratio (LTV).  Will lenders still adopt a vacant possession valuation or will valuation have to be based on the [potential] new longer term tenancy?  Vacant possession valuations have been adopted to date on the basis that if a lender repossessed it could sell quickly and still get market value.  That may not be possible with a 3 year tenancy and so, if these proposals go ahead, we might see lower LTVs in the buy-to-let market in the future.

A route to vacant possession could be for lenders or their receivers to rely on the mandatory ground for recovering possession, which is set out at Ground 2 of Schedule 2 to the HA [4].  However that option will simply not be available in all cases and, even where it is legally possible, it will involve the time, cost and inherent litigation risk associated with any court proceedings.

If, following this consultation, it appears that the proposals may be approved, lenders may wish to give serious consideration to the review and amendment of their minimum tenancy term stipulation. Lenders may also wish to lobby the government to ensure that any new legislation includes a mandatory ground for lenders to be able to recover possession in the landlord/borrower arrears scenario explained above.

Wider implications?

Apart from the potential implications for lenders, the consultation may have wider unintended consequences.

For example, the proposals include rent reviews to take place no more than once-yearly and with the amount of increase to be agreed at the outset of the tenancy or capped at the rate of inflation in the Consumer Price Index or other measure. However, the impact of increases in interest rates may mean that the agreed rent becomes insufficient to enable the borrower to service the mortgage.

There is also the possibility that increased regulation in this already highly regulated sector may stifle institutional and private investment. That could cause further damage to a housing market which is heavily reliant on private rented stock.

Next steps

The government has confirmed that it also intends to publish a call for evidence in the autumn to better understand the experience of landlords seeking to gain possession via the courts.  It may be sensible for lenders also to feed in to that process and Walker Morris will continue to monitor and update on developments. In the meantime, the current consultation is only for 8 weeks in total and will close on 26 August 2018.

If you would like further information or advice, please do not hesitate to contact Karl Anders or Justin Coley.


[1] Source: New and outstanding buy-to-let new mortgages, UK (UK Finance) May 2018
[2] That protection allows a short delay to enable the tenant to find alternative accommodation
[3] For more information on the appointment and powers of receivers, please see our more detailed briefing
[4] i.e. where the tenancy was subject to a pre-existing mortgage; the mortgagee is entitled to exercise a power of sale conferred on it by the mortgage or by section 101 of the Law of Property Act 1925; the mortgage requires vacant possession of the premises in order to exercise that power; and the requisite legal notice has either been served or has been dispensed with by order of the court