The Economics of Assured Periodic Tenancies

 

EXECUTIVE SUMMARY

An Assured Periodic Tenancy (“AT”) is a modern form of tenancy created under the Housing Act 1988 alongside the more familiar Assured Shorthold Tenancy (“AST”). Originally the AT was the default tenancy in the absence of correct documentation (hence the use of the term “periodic”) however the act was amended so that the AST is now the default form of tenancy and as such AT’s are relatively rare today.

ATs have two key features:
• Rent is set at open market rates, as per ‘regular’ AST properties
• Tenants have notable security of tenure, which can only be brought to an end under specific circumstances such as non payment of rent and requires a court order to do so

From a landlord’s perspective, AT properties tend to:
• Have better conversion of rental income from “gross to net” given the typical lack of tenant churn which reduces or eliminates void periods and associated reletting costs
• Sell at a discount to vacant possession properties owing to the reduced market for these properties, namely exclusion of owner-occupiers. Having consulted with advisors, we benchmarked 10-15% as a reasonable discount to vacant possession. A reduced capital value further contributes to enhanced rental yields (rent divided by investment)
• Appreciate in value at a similar rate to equivalent properties not subject to AT’s, allowing tracking of local market capital values
• Revert to vacant possession value on departure of the tenant, eliminating the capital discount and providing immediate capital uplift

In summary, the advantage of an AT, provided that it has been priced correctly, is that it can offer the opportunity for enhanced income and capital returns relative to AST properties.

Introduction

Tenancy is governed by the law and there are different types of tenancy.

The most common type is the AST – these contracts usually last for 6 or 12 months, at the end of which the landlord can give notice, or the tenant can leave without renewing the contract. This form of tenancy is by far and away the most common form in the UK.

Another, less common, type of tenancy is the Assured Periodic Tenancy (AT). This article explains how AT works and what the economic implications for landlords are.

AT: key features

AT has two key features:
1) Tenants have notable security of tenure, which can only be brought to an end under specific circumstances such as non-payment of rent and requires a court order to do so
2) Rent is set at open market rates, as per ‘regular’ AST properties

Taking these features in turn:

AT tenants have greater security of tenure than AST tenants. AT tenants cannot be evicted, unless there is a strong reason (valid reasons are listed in the Housing Act 1988) that the landlord uses to seek a court order for possession. On the death of the tenant there are succession rights, although only one succession is granted under law. What this tends to mean is that AT tenants are sometimes in place for very long periods at a time (often decades).

AT rent is set at market rates. In other words, the rent received should be no different to an equivalent property that is rented under a more ‘regular’ form of tenancy such as the AST. If the tenant wants to contest the rent, they can take the dispute to a ‘rent assessment committee’ or to a tribunal for rent disputes, who will determine the appropriate rent by reference to open market rents. This option is one that is open even to ‘regular’ AST tenants.

AT tenancies: economic analysis

AT properties tend to have higher income from rent than ‘regular’ AST properties:
• In a given month, the monthly rent that an AT property generates should be the same as for a ‘regular’ rented property (an AST property) – the rent for both is at market levels
• However, void periods (when the property is not rented) should be shorter, or non-existent, since AT tenants tend to stay for the long term
• Another result of lower tenant churn is a saving on advertising costs (estate agents’ fees)

In combination, these factors result in higher net rental income from AT properties compared to AST properties.

AT properties come with one major disadvantage relative to ‘regular’ AST properties, which has an impact on the price of the former: owners do not have the option to move into an AT property until the tenant leaves (almost certainly, through their own choice)

This factor tends to result in a price discount relative to an equivalent ‘regular’ AST property. Having consulted with advisors, we benchmarked 10-15% as a reasonable discount to vacant possession. There is no evidence of the discount changing over time, so the capital appreciation expected is as for ‘regular’ AST properties.

However, on departure of the tenant this discount falls away. As such there is the opportunity to buy at a discount and benefit from additional uplift in value through the reversion to vacant possession value on departure of the tenant. However this can take a long period of time and for prudence we would caution against building this into any financial returns forecast.

Conclusion

In summary, AT properties tend to:
• Sell at a discount (10-15% lower than AST properties)
• Generate more net rental income (given reduced tenant churn and therefore voids and reletting costs)
• Appreciate in value at a similar rate to surrounding properties
• Offer the chance of enhanced capital returns should the tenants vacate

As a result, the advantage of an AT, provided that it has been priced correctly, is that it can offer the opportunity for enhanced income and capital returns relative to AST properties.

 
 
 

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