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What is today's blog about?
In this week’s blog, we take a look at the new RICS Professional Statement Valuation of Buy-to-Let and HMO Properties (2nd Edition).
This is essential reading for all residential AssocRICS and RICS APC candidates pursuing the Valuation and Loan Security Valuation competencies.
You can download the full guidance here.
When is the new guidance effective from?
1 December 2022.
Why has new guidance been issued by RICS?
Market changes have led to a substantial residential private rented sector (PRS) in the UK, primarily due to strong returns compared to alternative investment opportunities.
The new guidance recognises the current state of the PRS, which includes:
Single residential units
Houses in Multiple Occupation (HMOs)
Multi-unit blocks
The guidance applies to valuation work for both private and lender clients.
What are the three categories of buy-to-let properties?
The three categories of buy-to-let properties have been updated in the 2nd Edition guidance:
Category 1 – single individual residential unit let to a single household on a single AST (which is not part of a portfolio). This type of property may be subject to selective licensing in some cases
Category 2 – a small HMO let on a single AST to a group of individuals or separate ASTs with a minimum of 3 tenants (forming 2 households), up to a maximum of 6 tenants sharing communal facilities. This type of property may be subject to selective licensing, additional licensing or mandatory licensing where there are 5+ tenants
Category 3 – larger licensable HMOs with 7+ tenants and multiple units with an element of shared facilities, held on a single title. These may be let on a single AST to a group of individuals or on separate ASTs. HMO regulations will need to be complied with, together with this type of occupation falling into sui generis planning use
A key change is to Category 2 in the 2nd Edition guidance, which now reflects the HMO definitions used for planning purposes.
Valuers must have a clear understanding of HMO requirements and licensing, together with what is defined as shared facilities for shared houses, flats and bedsits.
Valuers also need to understand the PRS market, going beyond just basic knowledge. They need to understand the history and development of the PRS, together with broader issues such as underwriting standards for buy-to-let mortgages (e.g., affordability testing, interest rate affordability stress testing, portfolio landlords and risk management), financial services regulation and sector regulation (e.g., right to rent checks, fire, gas and electrical safety regulations and the Minimum Energy Efficiency Standard).
What do I need to know about recording the instruction?
As a specialist area of valuation, valuers need to be sufficiently competent, skilled, knowledgeable and experienced to take on this type of work.
Before accepting any instructions, valuers should work through Appendix A of the RICS guidance. This provides a helpful checklist that valuers should be able to satisfy before they accept this type of work.
When valuing for secured lending purposes, valuers need to ensure they are aware of the lender client’s specific guidance on buy-to-let valuations. This is generally separate from guidance for owner occupied valuations and will include guidance on approach and methodology.
The instruction should comply with VPS 1 of the RICS Valuation – Global Standards (Red Book Global), and specifically include:
‘Applicant details
Full address
Tenure details
Leasehold terms if applicable/known (lease length, ground rent and service charge)
The type of valuation required and report to be completed
The lender’s guidelines to be applied (separate document)
Access details – vendor/landlord/managing agent’s name and contact details
Purchase price or estimated value
Proposed loan amount
Rent passing or estimated rent and frequency
Number of tenants/nature of occupancy – single unit/sharers/multiple occupation
The service level agreement (SLA) that applies
Any intentions of the applicant (proposed works), if applicable’
What do I need to know about the basis of valuation?
Valuers should have a robust understanding of the underwriting process, including not just Market Value, but also the accuracy and sustainability of the Market Rent.
This should be assessed as per VPS 4 of the Red Book Global and not just simply by accepting the passing rent at face value. Valuers, therefore, need to assess relevant comparables as in any diligent valuation exercise. The assessment of Market Rent will be net of any inclusive utility costs and be on the basis of an unfurnished 6 month AST.
What do I need to know about legal and regulatory matters?
Valuers need to report on any legal and regulatory matters, which may then need to be verified by solicitors. This is because such issues may affect the use of the property and potentially result in local authority enforcement action, subsequently affecting the sustainability of the rental income.
Areas of relevant legislation include:
Homes (Fitness for Human Habitation) Act 2018 (relating to the basic requirements for a property to be fit for habitation at the beginning of and during a tenancy)
Housing Act 2004 (relating to the definition of an HMO)
Management of Houses in Multiple Occupation (England) Regulations 2006 (relating to a landlord’s duties to maintain and keep HMOs safe)
Licensing of Houses in Multiple Occupation (Mandatory Condition of Licences) (England) Regulations 2018 (relating to minimum bedroom sizes)
Part X of the Housing Act 1985 (relating to statutory overcrowding), although a more modern standard is found in Part 1 of the Housing Act 2004
Housing Health & Safety Rating System (HHSRS)
Regulatory Reform (Fire Safety) Order 2005 (as amended)
Fire Safety Act 2021
Building Safety Act 2022
Licensing of Houses in Multiple Occupation (Prescribed Definition) (England) Order 2018 (relating to mandatory HMO licensing requirements)
Parts 2 and 3 of the Housing Act 2004 (relating to additional and selective licensing)
Housing and Planning Act 2016 (relating to banning orders for landlords and agents)
Town & Country Planning (Use Classes) (Amendment) (England) Regulations 2020 (relating to residential use classes)
Leasehold Reform (Ground Rent) Act 2022 (relating to the abolition of ground rents for new, qualifying long leasehold properties)
By reading the RICS guidance, valuers can find out further detail on the above, which should be supplemented by regular, specific CPD.
What do I need to know about inspection?
When inspecting, valuers must adhere to VPS 2 of the Red Book Global and UK VPGA 11 of the UK National Supplement (if the property is a single buy-to-let investment).
The assessment of Market Rent will be based upon the actual condition of the property at the valuation date, not on the assumption that any repairs or improvements will be made (unless a Special Assumption is instructed by the client).
Valuers need to assess the standard of accommodation, the lettability of the accommodation and the expectations of the local target tenant market. For example, is the property readily lettable and what level of rent is achievable in the current condition?
The valuer may determine that essential repairs to make the property lettable may have a material impact upon value, e.g., extensive works or complete refurbishment. Depending on the lender’s requirements, these could be dealt with via a retention or declining the loan.
Minor issues such as dated fittings or marked decorations are unlikely to lead to a property being declined, although they may affect the Market Rent that is achievable.
In a similar manner, the valuer may deem that non-compliance with legal and regulatory matters substantially impacts upon value.
How should I value a single residential unit?
When valuing a single residential unit, such as a flat or house, to be let on a single AST, valuers can use the comparable method to assess both Market Rent and Market Value (using owner occupied sales).
In some areas where the majority of housing is rented, valuers may base their opinion on comparable investment transactions.
The assessment of Market Value should include the Special Assumption of vacant possession, unless the client requests otherwise.
How should I value an HMO?
A similar approach to a single residential unit can be adopted, i.e., the comparable method using owner occupied sales.
However, where the market dictates (as above), then comparable investment transactions may be used instead.
In some areas, there will be a premium attributable over and above an owner occupied house given the alterations and adaptations made to a HMO property. Valuers may then decide to use the investment method, where a Market Rent and market-based (gross) yield will need to be analysed to calculate the Market Value.
In some complex cases, a net yield analysis and approach may be more appropriate. This could be where there is high management input and other significant costs, e.g., health & safety management plans, HMO licensing and higher insurance premiums.
The assessment of a market-based yield will also include an assessment of the tenant’s risk profile, e.g., tenant turnover, costs of eviction, management and housing allowance payments.
The investment method can also provide a useful cross check to the comparable method and provide further justification for the valuer’s opinion of value.
The valuation rationale adopted will depend on the local market, e.g., HMO in a predominantly owner occupied area, HMO in a mixed area or HMO in an area subject to an article 4 direction.
Further guidance is given in Section 4.4 of the RICS guidance.
What other issues should I consider?
There are various other areas for valuers to consider, including:
Buildings insurance and reinstatement cost, if requested by the client
Leasehold property ground rents and onerous covenants
Minimum Energy Efficiency Standard (MEES) and minimum EPC rating of E required to let a property, with a proposed increased target to C in 2025
Flood risk
Financial crime and red flags, e.g., of a property being let as an HMO but being presented as single occupancy
Refurbishment loan products
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N.b. Nothing in this article constitutes legal, professional or financial advice.