The Bartlett Real Estate Institute


Automatic Affordability Tenure [Property Chronicle]

23 April 2020

Covid-19 presents an opportunity for clear-headed policy makers to effect changes that might have taken a decade or more to put in place were it not for this crisis.

Houses in Sussex

Around the world, landlords of all types are being asked by tenants, or even required by governments, to waive rents, grant rent holidays or write off arrears as tenants struggle to stay in business and household incomes fall or disappear.  Bizarrely, real estate advisory companies are reporting that ‘rents aren’t falling’ which illustrates the odd phenomenon in 20th century real estate which separates ‘headline rents’ from real cashflows. Of course rental income is falling and impacting the cashflow of landlords significantly.  But new lettings, along with other transactional activity, has all but ground to a halt in towns and cities across the world.  This means that new prices are not being set in a world where there is no transaction record.

If the industry paid attention to net effective rents (which take into account rent holidays, fit outs and other rent incentives and voids) rather than gross ‘headline’ rents, we would hear reported an immediate and substantially downward trend in rent levels across most geographies and sectors, from retail to residential.

For most long-term landlords, painful though the cashflow implications are, rent holidays are not only equitable but also sensible.  Why bankrupt an otherwise good tenant with rent demands at a time of temporary crisis from which most businesses and households will eventually recover?  Evictions don’t make sense unless investors want vacant buildings or what could be a very long void period.

Covid 19 is perhaps the crisis which finishes off the Zombie companies in a way that monetary policy in the post QE age was unable to do.  But most companies and households do have a long-term future from which good landlords will enjoy the benefits – if they themselves can endure these tough times now.  The issue for policy makers and Treasury is whether they should help landlords in order that they help tenants. How can government ensure that good landlords continue to provide the shelter that all of us in our private and work lives need - while not bailing out bad, over-indebted, exploitative or ‘zombie’ landlords?

One solution is to make certain requirements of landlords in return for rent subsidies, guarantees or loans.  This crisis presents an opportunity for clear-headed policy makers to effect changes that might have taken a decade or more to put in place were it not for this crisis.

In the residential sector, I think the time has come for a new type of housing tenure which automatically creates affordability for tenants, incentivises landlords to provide long and secure tenancies and enables risk to be more equitably and efficiently shared between, landlords, tenants and the welfare system.  The widespread adoption of this tenure should protect tenants, align tenants’ and landlords’ interests more closely, make it easier the private sector to provide affordable housing while reducing the burden of housing benefits on the public sector at times of recession and crisis.

Automatic Affordability Tenure (AAT) is a method by which landlords, and the public sector can share the increased risk at this time and which could start to create a stock of more affordable rented housing.  In return for being guaranteed a minimum rental income by the state during the pandemic, landlords would be required to convert the tenancy to an AAT.  As soon as their tenant is back on their feet, landlords will benefit from rental uplifts, up to and including full market rent, while enjoying the minimum threshold rent of 25% of the lowest decile household income in the local travel to work area (TTWA), for example, plus income tax relief.

AAT would mean a new type of contract between landlords of all types (private, local authority, registered providers and employers) and tenants. It is based on the simple proposition that a tenant can elect to either pay full market rent for a property or 25% of their (post tax) household disposable income (they will clearly elect to pay whichever is lower).  The rent receivable by the investor rises if tenants prosper so rent rolls have the potential to grow above the rate of market rent growth but automatically fall at times of financial stress or impecunity. Importantly for the tenant, a fall in household income does not mean eviction, provided they continue to pay 25% of any income they have above a pre-determined threshold. Tenure lengths might be set at 10, 20 or even 50 years and eviction only possible for non-payment or rent and other pre-defined exceptional circumstances.

In return for providing sub-market rental housing, landlords will need to be compensated and incentivised.  One incentive is that, if they provide good housing in an attractive neighbourhood and the tenant stays, they are not stuck with a permanently below-market rent and may eventually be in receipt of full market rent over a period of time.  The rent paid within this tenure might range from a social rent to a sub-market rent to a full market rent within the span of a single tenancy. Over large portfolios, rent rolls should track household income growth rather than market rent levels.

A further incentive for landlords would be provided by exempting them from income tax on rent received.  This has the potential to encourage single property owning private landlords into this type of tenure as well as housing associations and other large-scale providers.

The final incentive would be an effective and timely public-sector backed guarantee that rents will not fall below a certain level. This could be provided by local authorities or a central government organisation but would effectively mean that as soon as tenant income falls below a pre-defined threshold, rent is paid from the public purse direct to the landlord.  This guaranteed threshold rent might be set at, for example, 25% of the lowest decile household income in the local travel to work area (TTWA).  (Such a threshold would also have the beneficial side-effect of providing a model-able metric to help planners and developers determine land values for social and affordable housing).

AAT takes inspiration from the use of ‘turnover rents’ in the retail sector and so the principal could be extended to commercial tenures as well as residential.  (This could work particularly well for small ‘neighbourhood commercial and sui generis uses in mixed use schemes). Turnover rents enable landlords to not only accommodate small independent shops who can’t afford full commercial rents but also to participate and enjoy their ongoing success and prosperity. This alignment of interests between landlord and tenant encourages the long-term, active stewardship and management of places for the benefit of occupiers.

AAT should change the relationship between landlord and tenant and can result in an active and mutually beneficial partnerships where both benefit from the tenant’s success but share the burden in times of difficulty. Landlords are incentivised to make investments in their property which benefit the tenant because they will quickly share in any uplift in well-being and prosperity that results.

The incentives provided by AAT are greater for longer-term landlords with active ESG plans who are willing to take a stewardship role, who are looking for their value and returns in the form of long-term income streams rather than short-term trading gains.  This includes, but is not limited to, housing associations and local housing companies.

One of the many long-term effects of C-19 is a realisation that landlords and tenant’s interests are much more closely aligned than the typically adversarial relationships of the past.  This alignment is not a direct result of the virus but because of changing economic and social conditions which were in train long before some ill-fated wild animals got infected in a wet market in Wuhan.  It would be a sad thing indeed if there were no advances made in our industry after all the suffering that has been, and will be, endured over coming months.

Professor Yolande Barnes