Feature: What are the common pitfalls when it comes to residential lending?
By Emma Stevenson-Smith, legal assistant at Thomson Snell & Passmore
There are a number of issues which should be checked carefully when taking security over residential properties. Below are some of the most common issues we encounter.
Planning and building regulations consent on new builds
These properties will have been built recently pursuant to planning and building regulations consents issued by the local authority. The planning permission should be checked to ensure that works have been commenced within the allotted period of time, and that any pre-commencement planning conditions have been discharged to the satisfaction of the local authority as required. These conditions can require the developer to carry out various remedial works in respect of contamination, and/or to provide the local authority with surveys or reports, in order that construction is allowed to commence.
The developer may be in the process of discharging the pre-occupation planning conditions, and it is prudent to check that these applications have at least been submitted to the local planning authority. The contract should also oblige the developer to comply with the planning consent(s).
Additionally, the property should have been signed off by building control and the developer should be able to provide a building regulations completion certificate/final certificate, confirming that the property has been signed off by building control, together with the 10 year warranty for the property provided by NHBC/LABC or a satisfactory equivalent.
Missing building regulations consents
Residential lenders will often only have a very basic desktop valuation undertaken. Although these should reveal any works carried out, they often do not. For instance, a valuation may state that no works have been carried out, but it is clear from the photographs that things such as loft extensions and side extensions have been added. It is important to check the photographs attached the valuation report, the local authority search result and the seller’s replies to the property information form in order to establish whether alterations have been carried out.
If major structural works have been carried out without building regulations consent, the lender may require a structural engineer to inspect the property or for the seller to obtain retrospective consent from building control. However, if they are only minor works and/or historic, then potentially an indemnity policy may suffice in the place of the building regulations certificate. However, it is important to note that an indemnity policy will only provide cover for the risk of local authority enforcement, and not for any structural issues.
If a local authority were to enforce, then it could require the borrower to remove the works, or rectify the works to comply with building regulations, and if the enforcement notice is not complied with, then the borrower may be subject to an unlimited fine.
Houses in Multiple Occupation (HMOs) – licensing and planning considerations
HMOs are subject to more regulations than a property tenanted by just one family or tenant. These should be taken into account when lending. The main points to check are licensing, planning and the lease (if the property is leasehold).
Any HMO tenanted by 5 or more persons forming more than one household must have an HMO licence. In certain areas, local authorities have imposed additional licensing schemes, which require any HMO tenanted by 3 or 4 persons forming more than one household to have a licence.
Some local authorities have passed Article 4 directions which remove permitted development rights which would otherwise allow a change in the use of a property from Class C3 (residential) to C4 (HMO) without planning permission. If the property is within one of these areas and has been converted to a C4 HMO from a single residential dwelling, then planning permission will be required. Planning consent will be required for change of use for Sui Generis HMOs (tenanted by more than 6 tenants forming more than one household) regardless of whether the local authority has imposed an article 4 direction. This requirement is in addition to the requirement to hold an HMO licence.
If dealing with a leasehold HMO, then it is important to check that the permitted use of the property in the lease allows the property to be occupied by more than one family or tenant.
Landlord’s insurance obligations in long residential leases
A lot of residential leases, especially leases which are more than 10 years old, impose inadequate insurance obligations on a landlord i.e. the lease does not set out what happens in the event that the landlord is unable to reinstate or rebuild the property and they do not require the landlord to hold the insurance monies on trust for the tenant and/or to repay these to the tenant. Clearly that will have implications if you are also acting for a lender.
These issues can be dealt with by obtaining a contingent buildings insurance indemnity policy, if the lender is prepared to accept this. The terms of these policies should be checked carefully to ensure they provide cover for the exact risk involved. It may be that some lenders require a deed of variation and the landlord would have to be approached about this, although there is no guarantee that a variation will be agreed, especially if the property is within a large block where all of the leases are in an identical format.
Assured Shorthold Tenancies (ASTs) and tenancy deposits
It is preferential for ASTs to include wording which allows a lender to obtain possession of the property if acting under a power of sale – i.e. under Ground 2, Schedule 2 of the Housing Act 1988. Lots of newer ASTs will include this wording, but older ASTs may not. If this wording is missing from the AST, it may be that the lender is prepared to proceed on the basis that possession can be obtained under s.21. If so, then it is important to check that the following documents have been served on the tenant prior to the tenancy commencing:
· Prescribed information relating to any deposit paid by the tenant
· A gas safety record dated within the last 12 months (if the property is connected to gas)
· The How to Rent booklet
· A valid EPC with an energy efficiency rating of E or above
· An EICR (electrical installation condition report) dated within the last 5 years if the property was let on or after 1 July 2020
It is also important to check that any deposit paid by the tenancy has been protected in a tenancy deposit scheme.
Housing Act repossessions
This should not be an issue going forward for new leases, as the Government is introducing the Leasehold Reform (Ground Rent) Act 2022, which will come into force on 30 June 2022. This will prohibit landlords from charging ground rents above a peppercorn on new residential leases.
However, there is still the issue of the level of ground rents being paid under leases granted prior to the introduction of this legislation.
It is important to check the level of ground rent payable under existing residential leases and any rent escalation clauses. In London ground rent must be £1,000 per annum or below, the ground rent paid in the rest of the country must be £250 per annum or below.
If the rent is above this, or if a rent escalation clause in the lease allows the rent to rise above this in the future, then there is a risk that the lease would be an assured tenancy within the meaning of the Housing Act 1988 and therefore a landlord could potentially apply for possession under Ground 8 of Schedule 2 of the Housing Act 1988 for arrears of the rent. This is serious because the court has no discretion to refuse to make the order for possession if proof of arrears is provided.
If a variation cannot be agreed with the landlord, then there is also the option of a Housing Act repossession indemnity insurance policy, but the terms need to be checked carefully and reported to the lender.