How to fix the rental market for real

we need an understanding that better ways are needed for setting rents on longer term tenancies, that these will need the buy in of landlords and their agents, and that they will involve an accurate reflection of local market rents.  The history of their development in Germany suggests they were pioneered at a municipal level before being required nationwide by central government, but still operated locally.  Even if the data used in the most sophisticated German municipalities is not immediately available for any UK local government, a lot of data will be available across different parts of government, and a better system than currently available for setting rents on longer term tenancies could be developed. It needs one local government to pioneer such an approach, and a department of central government to sponsor it.

The BBC reports today on new government plans to get longer tenancies

Renters would get longer tenancies under government plans

and links to these explainers published earlier

Reality Check: How does renting a home in the UK compare?

Four ways to fix the rental market

The comparisons with other countries show how things could be different.  Most striking is Germany:

In Germany, which is often touted as a renting paradise, tenants can stay indefinitely and will face eviction only if they break the law: for example incurring rent arrears or using anti-social behaviour.

Even a landlord selling up does not necessarily result in tenants having to move on, and in some cases children can even inherit tenancies from parents.

How can this be?  For a landlords, letting a property indefinitely is risky if the rent could end up being significantly less than they could get if they relet to a new tenant, at market rates.  And yet, about half of all housing in Germany is privately rented, so there can be no shortage of willing landlords. 

Table 2008 Rugg Report

These landlords are much the same as the small buy to let landlords in the UK.  According to the authoritative source in English on the German PRS,

In Germany individual investors comprise of approximately 60% of the market and the average size of individual holdings …  can range from six to 45 dwellings.

Source: The German Private Rented Sector – A Holistic Approach

There must be a way the rents on these indefinite tenancies can track local market rents, and there is.  It is called the Mietspiegel – “Rent Mirror” – and from pages 28-29 of this report

The Mietspiegel is an objective and statistical calculation of the customary local reference rent.

and

The Mietspiegel essentially offers two practical roles:

I. Tenants are able to refer to the Mietspiegel easily to see whether their rent price is in accordance with the customary local reference rent. Should this not be the case then the landlord will have to use the other methods of rent increase, under a much higher burden of proof, to justify the prices. Alternatively, the ease of reference to the Mietspiegel reduces the likelihood that the landlord would attempt to increase rent above the locally comparative rent. For the tenant, the Mietspiegel primarily ensures that the landlords remain easily accountable for rent increases, with any speculative increases
unlikely.

II. Landlords are able to increase the rent in accordance with the market they have invested in by easily referring to the Mietspiegel. This knowledge that the Mietspiegel reflects the customary local reference rent ensures the investor that they will always be getting the natural dividend for the general supply and demand of the market. Should the tenant choose to dispute a rental price which is appropriate according to the Mietspiegel, they will have the legal burden of proof to show it is incorrect. For the landlord, the Mietspiegel primarily ensures that they are uninhibited with ensuring an appropriate
market income level is set without obstruction of the tenants.

This sounds similar to the what the BBC describes here

2. Limit rent increases

Many European countries impose limits on rent increases.

In Ireland and parts of France, they are controlled according to market levels in the same area.

although in the German system – and comparable systems elsewhere – government does not strictly limit rent increases.  The control ‘according to market levels in the same area’ results from a long term agreement entered into between landlord and tenant.  The main government role is to support the publication of reference data for use in these long term contracts.  Formally, the legislation requiring this came from central government:

In response to increasing rent, three principals were enacted in the Housing Employment Protection Act 1971:
· Rental increases must reflect comparable market prices
· Unilateral security of the tenancy
· Free negotiation of rent in new leases
The 1971 Reform implemented in practice a rent index, although only through the principle of rents being comparable to the market prices.

with the obligation to implement a Mietspigel put on local government, although, they were given a fair degree of flexibility in how.  Smaller local governments were allowed a simple relatively informal agreement

The simple Mietspiegel has sometimes between referred to as the “Bordeaux-Mietspiegel”, whereby the tenant and landlord associations in certain towns have come to collective agreements as to the figures in the Mietspiegel over a bottle of wine, rather than by a statistical methodology.

while larger municipalities invested in sophisticated econometric modelling.  For some municipalities, however, it may not have been anything new, reflecting a culture of local government engagement in a healthy private rented market

 

In itself this is not exactly regulation, because when negotiating a new rental agreement, landlords can still ask for higher rents, or may agree to lower rents if the property is hard to let.  These new rents will then be reflected in the local “Rent Mirror”, and so result in changes to the rents paid on all tenancies using it.  Government regulation outlaws rent rises of more than 20% over three years, but with relatively low inflation, this will not generally be relevant.

Could this work in the UK?

Of course it could.  The two main obstacles are:

  1. Section 21 ‘no fault’ evictions give landlords of assured shorthold tenancies all the power they need to “ensure an appropriate market income level … without obstruction of the tenants“, and
  2. Lack of a German style “Rent Mirror”

Without the second of these, the abolition of Section 21 evictions is likely to lead to landlords getting out of the sector.  Most properties affected will then be sold for owner occupation, so making housing more affordable for those just about able to buy – although in a weak market, this may not be a great idea. For those for whom there is no prospect of buying at today’s prices, and who ever want to move, it is bad news, because the supply of rented properties will go down, and they will end up paying more rent.  Since most renters do expect to move, this means most renters will lose, even though the abolition of Section 21 will benefit existing tenants until they do want to move.

Getting a German style rent mirror will require pulling together what data is available about rents at a local level, and there is a long standing requirement that rent increases must be:

Fair and realistic, i.e. in line with average local rents

Source: Gov.uk: Private renting

However, this is likely to apply mainly to old style regulated tenancies, where landlords do not have the power of Section 21. On the face of it, the methodology used to calculate such “fair and realistic rents” could be used to publish UK Rent Mirrors, but landlords and their agents will be suspicious.  I have anecdotal evidence of a recently assessed “fair and realistic rent” on a regulated tenancy resulting in a rent per sq. metre about 50% of the market level for similar nearby properties.  The history of the UK private rented sector, which was stalled before the introduction of assured shorthold tenancies, with the power of Section 21 for landlords, also suggests that “fair and realistic rents” have not been in line with local average rents. It is conceivable that a new Rent Mirror could be introduced in parallel, which landlords would trust to “ensure an appropriate market income level”, but it would be perverse not to use the knowledge base of government agents – staff of the Valuations Office Agency – in this.  To progress, we need to understand more about how this current system operates, and help it develop into one which can succeed in really fixing the private rented sector.

In the meantime, we should be pushing out the horizons for rental agreements, as suggested by Shelter

 Shelter would like to see rent increases tied to inflation within five-year tenancies. This would enable tenants to plan their finances, but allow landlords to obtain market rents at the beginning and end of each five-year period.

An obvious problem with this is a lack of ambition – if unlimited tenancies work in Germany, why do we need to limit the horizon of renters to five years? Another is that indices for inflation, such as RPI, reflect prices across the whole economy, so will not accurate follow changes in rents, and in particular not local rents.  Currently, RPI is rising faster than rents, reflecting the weakness of sterling in anticipation of Brexit, which is also reducing demand from renters.  A contract with rent increases tied to RPI would have tenants paying well over market rents by the end of the five years.  They could of course move out, leaving landlords with the costs of finding a new tenant, so landlords would have an interest in finding an index which more accurately tracks local rents.  Such an index is available, the Index of Private Housing Rental Prices, with data by UK region since 2005, but still described as 

An experimental price index tracking the prices paid for renting property from private landlords in Great Britain.

It would certainly be better to use this than RPI for longer term rental contracts, and using regional rather than the national indices, but more local indices would probably go beyond the ONS methodology.  However, getting their methodology to join up with the VOA approach would be helpful.

There are also a lot of law which would need to be cleared up. As an economist rather than a lawyer, it’s an area I approach with caution.  Some recent online research came up with this advice on extending the term of an AST, from a forum for landlords

There is no maximum length but it is meant to be for a relatively short period otherwise why would it be called an Assured Shorthold Tenancy?

These are the defining lengths of the term where matters can change:-

1. For a term of 3 years or under it does not have to be witnessed and can be drawn up by a landlord & tenant quite simply.

2. Over 3 years then it does have to be signed as a deed and witnessed.

3. If you want to grant a tenancy of more than 7 years then you should use a tenancy at common law as you could make a tenant responsible for all repairs if you wanted to! (quite common in commercial tenancies). You would need to ensure it does not come under the Landlord & Tenant Act 1954 or you could be stuck with the tenant.

4. For tenancies over 21 years then different rules apply.

The moral is therefore keep it short!

The moral I draw from this not to keep it short, but to make sure lawyers as well as economists are involved in fixing the rental market for real.

Before anything, however, we need an understanding that better ways are needed for setting rents on longer term tenancies, that these will need the buy in of landlords and their agents, and that they will involve an accurate reflection of local market rents.  The history of their development in Germany suggests they were pioneered at a municipal level before being required nationwide by central government, but still operated locally.  Even if the data used in the most sophisticated German municipalities is not immediately available for any UK local government, a lot of data will be available across different parts of government, and a better system than currently available for setting rents on longer term tenancies could be developed. It needs one local government to pioneer such an approach, and a department of central government to sponsor it.

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