The government has announced a package of reforms for the lettings market including a new ‘model tenancy agreement’ which is intended to deliver longer term rentals, giving tenants more stability than the six month terms generally used now. Will it work? And ho do rental markets in Europe work?

Although most rental markets in the EU look fairly similar, in that rent levels are (relatively) freely determined by landlord and tenant, once you look at the detail some major differences become apparent.

The International Union of Property Owners, of which the National Landlords Association is a member, carried out a comparative analysis; this shows lease durations ranging from six months in the UK to nine years in Belgium, and also points out that formal registration of leases is required in five of the countries studied (Greece, Spain, Belgium, Ireland and Italy).

THE LONGER LEASE

Almost everywhere in Europe, rental periods tend to be longer than in the UK. In many countries, such as Austria and Norway, it’s three years; in Belgium, it’s nine. Though shorter periods are allowed, notably for furnished holiday lets, nine is the standard and if a shorter let exceeds three years in duration, it will automatically become a nine year lease, backdated to the initial period of the tenancy. In Germany, on the other hand, it’s illegal to write a fixed term rental contract; all leases are by their nature unlimited in duration. Indeed, most areas of the contract are covered by legislation; there’s not much room for negotiation on the part of either tenant or landlord.

France, lease length differs based on the type of both accommodation and landlord. Furnished accommodation rents for a year, while unfurnished accommodation rents for three years if the landlord is an individual, but six years if the landlord is a company. The division between furnished and unfurnished is quite sensible; tenants who have their own furniture are naturally going to want a longer lease with less disruption to their lives on a house move – particularly since ‘unfurnished’ in France often means no carpets, no curtains, no kitchen and no light fittings.

Norway distinguishes between ‘business’ landlords (three years) and those renting out their own homes (one year). Those distinctions could be useful to the UK market, in making the distinction between individual (particularly ‘accidental’) landlords, and institutional landlords to whom secure long-term tenure is most attractive.

LEASE RENEWALS

The biggest difference, though, is in how renewals are handled. In Greece, the initial three year lease, if renewed, reverts to one month’s notice, and either party can break the tenancy without compensation. In Austria, on the other hand, if no termination notice is given, it rolls over into a new three-year contract. This type of renewal appears most common – in Italy, for instance, tenancies renew for two or four years.

Initial rent levels are freely determined in all the major European markets, but there are limitations of various kinds on the landlord’s freedom to set a rent. In Austria, rental scales are set by local authorities, and in Norway “unreasonably high rents” are unlawful – that is not defined, but appears to be policed by comparison to similar properties on the open market. Germany is very strict; it can be a criminal offence to charge more than 20 per cent above the market rate. (It’s also worth noting that in France, landlords who have taken tax breaks on the provision of new build residential property are often committed to offering the property below a specific level of rent, which varies depending on the scheme they subscribed to.)

RAISING THE RENT

Increases in rent during the contract period are more heavily policed, though it’s rare for regulated rents to be applied; only Austria sets rents centrally. Often, increases in rent are related to inflation; in Italy, after the initial contract term, rents cannot be increased by more than 75 per cent of the cost of living, keeping rents depressed. In Germany, the contract will stipulate the type of increase – often inflation linked.

Other countries use methods of comparing rent increases to the market. In Ireland, annual rent reviews adjust the rental level in accordance with market valuations. In France, an elegant solution is the Rent Reference Index (IRL), which dictates the amount of increase, but not overall rental levels. There are a few exceptions; for instance, when the rent currently being charged is significantly below the average for the area, or when the landlord has completed major renovations, in which case there is a detailed schedule of increases allowed, depending on the ratio between the renovation cost and the annual rental level.

Intriguingly, Jonathan Morgan, Managing Director of Leeds agency Morgans, believes a CPI link would hurt tenants in the UK. He points out that private sector rents over the last eight years have risen, on average, by less than inflation.

TERMINATING A LEASE

What happens when the lease expires? That again differs, but one common factor is that termination arrangements are generally asymmetrical. In many countries the tenant doesn’t need to show any cause for early termination, or has to give a lesser period of notice than the landlord (three months against six months in Belgium). In France, the landlord not only has very limited grounds for giving notice, he actually has to show a valid reason for refusing automatic renewal of a lease; while tenants generally need to give three months’ notice, shortened to one month if the tenant loses his job, is over 60, or in bad health. Evictions can take up to 18 months. Needless to say that’s not particularly attractive to landlords.

In Germany, landlords have an even worse draw. The landlord can only terminate the agreement in order to move back into the property as his main residence, to demolish the building, or if the tenant is in serious breach of the contract. With owner occupancy at only just over 40 per cent, German governments tend to take renters seriously.

The US is less regulated. A few, mainly major urban markets have introduced regulation to cope with spiralling rents and short supply of rental properties – New York, New Jersey, San Francisco and Washington DC. Everywhere else, rents are unregulated. Rentals are divided between a short term rental market, with 30-day minimum periods and automatic renewal unless notice is given, but where a landlord can easily change the terms of the contract, and a longer term market for leases of typically six months to a year, which aren’t automatically renewed but revert to monthly leases. In the case of default, the system works to landlords’ advantage – from a ‘pay or quit’ notice to eviction can take as little as 49 days.

However, the decision of major cities to introduce rent control suggests that while this works well when there is a good supply of rental property, it works less well in areas where high economic growth can’t be matched by increased housebuilding.

CHANGE FOR THE GOOD?

So is the proposed change a good one? Is it actually a change at all? Alan Ward, Chairman of the Residential Landlords Association, says the announcement was “a recognition that the existing tenancy framework already enables tenants and landlords to opt for longer tenancies without the needed for heavy handed legislation” – in other words, it doesn’t change very much. While five year rental terms remain exceptional, the Assured Shorthold Tenancy (AST) does indeed allow any length of contract term to be included. He’s particularly glad that the government appears to have decided against imposing a rigid standard five year contract, as Shelter suggested.

Most agents don’t believe much is going to change. Susan Emmett, Director of Residential Research at Savills, points out that landlords do already offer three year tenancy agreements,
for instance at the East Village development in Stratford; and Lucy Morton, Senior Partner at WA Ellis, while describing the announced package as “a positive step,” says her firm’s average tenancy length is already more than three years. “Often,” she says, “it’s the landlord who will commit to a longer term and the tenant who wants the flexibility of a break after six months.”

In fact, though Eric Pickles suggested the market wasn’t working properly for tenants, figures from BDRC Continental and Allsop LLP show that tenants stay, on average, two and a half years in their rented property, and 41 per cent of tenants have stayed in the same property for over four years. So although the current system may not guarantee tenants’ security, it’s certainly delivering it for many. It’s rewarding them, too – Michael Ball, Professor of Urban and Property Economics at the University of Reading quotes the English Housing Survey which shows that longer term tenants tend to have lower average rents than recent ones. So market mechanisms are working as they’re meant to.

Not all tenants want long rental periods. Younger tenants – over half of all private sector tenants are under 34 – are less interested in security of tenure than in saving towards eventual owner- occupancy. Professionals on secondment, and other tenants who have to move for work reasons, are also likely to prefer a shorter term.

Jonathan Morgan says that tenants who want longer term agreements often get discounted
rates. “Landlords like to have these tenants as they provide a guaranteed rental yield,” he says, “but there is absolutely no need to make it mandatory, there must be a level of flexibility.”

WILL WE LIKE IT?

With no compulsion behind the proposals, and no changes to the law, will the long-term contracts proposed by the government actually be adopted? One of the difficulties is that agents, landlords and tenants are used to using the standard six month AST; the inherent flexibility of the tenancy agreement isn’t always used.

It might be more sensible for agents to recognise the segmentation of the market by offering two or three types of contract, say a six month, three, and five year contract, depending on the type of property and likely desires of tenants.
There are also practical problems with longer tenancies which need to be addressed. Most Buy-to-Let mortgages stipulate that tenancies can’t be for more than a year; five year leases would put such landlords in breach of their mortgage contracts. It’s fair to point out that Nationwide allows tenancies up to three years in length, and Paragon doesn’t have a cap.

The government says it is consulting with lenders, but the rules are there for a reason, says Graham Kinnear, Managing Director of Landlord Assist. “Extended tenancy agreements may impact a bank’s security,” he explains; if a landlord fails to pay the mortgage, the bank may not be able to secure vacant possession. This could have a negative impact on the capital value of the property, as the existence of protected tenancies already does. He believes that this could make a move towards longer standard tenancies counterproductive, and reduce the availability of rental accommodation.

More important for lettings agents is the fact that fees associated with tenancy renewals add up to a useful source of income. Less churn means lower revenues, agents will have to make up the shortfall. Graham Kinnear says, “We expect letting agents to increase their administration fees for longer tenancies when compared to six month rents,” he expects landlords to pass the cost on to tenants through higher rents.

The treatment of rent reviews within longer tenancies also needs to be finalised. With increasing rents, landlords will be loath to sign up to long agreements without the right to a review; but tenants’ interests also need to be protected.
Professor Ball believes that proposals for longer tenancies miss the point. “The real cause of rising rents,” he says, “is a chronic lack of housing supply.”

That’s another discussion altogether, but here’s a thought: for many years, councils and housing associations provided exactly the kind of affordable homes and rental stability that many tenants needed. Maybe increased government support of councils and housing associations would do far more than tinkering with the AST system to give them what they need.