Tenant arrears: Expect the best, but plan for the worst, advises Paul Jardine, director and receiver at Templeton LPA
September brought with it a flurry of good news for prospective property investors. Rents rose for the eighth month in a row according to LSL’s latest Buy-to-Let Index, and at 5.2%, yields have reached their highest level in over three years.
But behind these figures was an even more significant statistic for landlords. Rental arrears had taken a sharp turn for the better. Last month, just 8.6% of all rent was late or unpaid – the lowest total since April 2010, and a substantial drop-off from the 10.7% in August.
In fact, tenants’ finances have been in far better shape than many anticipated, given the rise in rents, the ongoing economic gloom and public sector job cuts. In 2011 so far, the average amount of UK rent in arrears has remained stubbornly low at 10.3% – compared to an average of over 11% two years ago.
This has been reflected in buy-to-let borrowers’ improved ability to meet their monthly mortgage payments. In Q2 2011, 29,100 buy-to-let loans were more than three months in arrears – a drop of 15% compared to a year ago.
Low rates too, have played a role in the drop in mortgage arrears. According to Defaqto, buy-to-let mortgage rates have dropped by nearly 1% in the past year, with an average two year fixed rate at 4.86% and an average five year fixed rate down to 5.69%. Falling mortgage payments, contrasted to rising rents, has provided landlords with a financial buffer against mortgage arrears, and many have taken the prudent step of saving the surplus rent as a slush fund against a time when rates rise – or their tenants run into payment difficulties.
However, tenant arrears will eventually rise, and property investors need to be prepared.
Unemployment has been growing for several months, hitting 8.1% in August – up from 7.7% in March. As public sector losses continue, an increasing number of tenants will find their employment situations changing at a time when rents are still rising.
At present, the annual rate of rental inflation is almost double the annual wage growth, as frustrated first-time buyers continue to increase demand for rental accommodation. In the last 12 months, rents have risen by 4.3%, while wages have only increased by 2.8%. Shelter’s latest research suggests that ordinary families are already finding rents unaffordably high in 55% of local authorities. While rents increase faster than wages, more and more tenants will find their finances squeezed.
As economic factors take their toll on tenants’ disposable incomes, an increasing number of landlords may find themselves in arrears with their mortgage provider. In turn, LPA receivers like Templeton LPA are likely to see an increase in work, as lenders look to proactively manage these severe arrears cases.
However, there are several preventative steps investors can take.
Many landlords – and their property managers – are already adopting a more hands-on approach to catch and prevent rental payment problems early. Many are keeping open lines of communication with tenants to resolve payment issues quickly and amicably, while others are showing less forbearance with tenants facing payment issues, and are looking to swiftly replace them in the hope of higher rental income.
But when it comes to tenant arrears, offence is often the best form of defence. It’s crucial that new tenants are screened thoroughly, with comprehensive credit and reference checks performed, and proof of a tenant’s ability to meet monthly payments provided. This is normally part and parcel of the service of a good letting agent, but if you are going it alone, it’s a process worth investing time and money in to prevent issues further down the line.
Another option for landlords to consider is using excess rental income each month to either build a slush fund against a rainy day, or investing in rental guarantee schemes. For a cost of approximately 2.5% of monthly rent, landlords ensure that the scheme providers, such as LSL Property Services plc, cover lost rent of up to six months in the event of tenants’ non-payment.
Low tenant arrears rates have undoubtedly been a bonus for landlords, but property investors must not be complacent. As in all business, expect the best, but plan for the worst.