One door opens, another slams in their faces: rent arrears haunt landlords

Mortgages cost less, but unemployment is up – and tenants more likely to default. So how can buy-to-let investors protect themselves? Laura Howard reports
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The Independent Online

We're constantly being reminded that investments go down as well as up, but how many buy-to-let investors could have predicted the market would be this volatile?

After seeing at least 15 per cent wiped off the value of their property investments in the past year, it seemed that landlords on variable-rate mortgages could at last breathe a sigh of relief thanks to the recent dramatic cuts in the base rate. But already they are faced with a still graver problem: the growing prospect of rent arrears.

According to research published last week by the National Landlords Association (NLA), 71 per cent of landlords expect tenants to fall behind on their rent during the course of next year as unemployment shoots up and the credit crunch bites harder.

Richard Price, the director of operations at the NLA, says: "Regardless of how reliable your tenants are, things will always go wrong. The usual triggers are a change in relationship or, most likely in the coming months, loss of income through unemployment."

For landlords with just a few properties, the consequences of not receiving a steady income could be mortgage arrears and even re-possession. "If you have two buy-to-let places and one tenant doesn't cough up, that's half your rental income," says Mr Price.

In this case, there is always rent guarantee insurance to fall back on – a type of cover that will pay a landlord's rent if their tenant can't. "We have already seen a marked growth in the number of landlords inquiring about rental policies," says Suzanne Whittingham at insurer Endsleigh, "and we expect them to become a lot more popular next year as the downturn kicks in."

The insurance pays out until either the assured shorthold tenancy (AST) agreement comes to an end or a tenant has been evicted. Policies are typically capped at between £10,000 and £15,000 of rental cover and there is usually an excess of one month's rent to pay, or 90 days if you take out the policy once a tenancy has started. Also built into the cover is up to £25,000 for legal fees should you need to take your tenant to court.

Premiums for rental guarantee insurance start at just £99 for 12 months, though not every landlord will qualify, warns Tom Entwistle, the managing director at information website Landlordzone.co.uk.

"Insurers will insist that a tenant's financial history has been checked by a licensed credit reference company and shows no outstanding county court judgments. They will also need a written employer's reference and two forms of identification – one of which must carry a photograph. Landlords will also need to have drawn up a formal AST agreement."

And though insurance is a prudent measure for landlords, like anything else, it depends on the cost, says David Whittaker, managing director at buy-to-let broker Mortgages For Business. "I have heard of some policies costing a month's rent," he explains, "which is effectively an 8.5 per cent reduction in rental income."

He adds that, as premiums are also proportionate to risk, the price of all rental guarantee insurance could rise.

But in weighing up the value of a policy, landlords need to be aware that under the Housing Act 1988, tenants bound by an AST agreement can't just be thrown on to the street – even if they are not paying the rent.

"Eviction entails a lengthy and costly court process known as 'Section 8', under which you can apply for a possession order," says Mr Entwistle. "Many landlords don't consider the process worthwhile and prefer to wait for the AST to expire. That's why it's sensible to start off with a six-month contract and renew it if things are going well."

Meanwhile, says Mr Price, "some properties are not rated highly enough to get cover at all. "The bedsit end of the market is usually considered too high risk when it comes to defaults on rental payments."

Landlords can also try to minimise the risk of rental arrears by forging good relationships with tenants. "This way, if there is a potential problem, your tenant will come to you first and you can work things through to-gether," says Mr Price. He adds: "There may be some solutions, such as benefits, that your tenants didn't know they could qualify for."

More innovative schemes, such as offering a new tenant a discount on rent if they pay six months upfront, are also an option – but be very wary if this proposal comes from the other side of the fence. "This could be related to money laundering so credit checks are more crucial than ever," cautions Mr Price.

Alternatively, you could change your tenant base. "Next year will see us heading towards three million unemployed at a rate of knots, and no one knows what sector will be hit and when," says Mr Whittaker. "In this case, it could be students' landlords who now find themselves in the most reliable market."

But while it might be tough for landlords to get their hands on rent owed during 2009, at least their mortgage payments will have been tamed, says Melanie Bien, director of independent mortgage broker Savills Private Finance. "Falling interest rates are excellent news for buy-to-let landlords. Many have come to the end of fixed or discounted rates and have struggled to remortgage because there are fewer products available, fees are expensive, and their loan-to-value [LTV – the ratio of the mortgage to the value of the property] is higher than in the past.

"This means lenders have allowed landlords to revert to cheaper 'go to' rates rather than the standard variable rates.

"With 'go to' rates at 2 per cent above base, this means a pay rate of around 4 per cent, which on buy-to-let deals is unimaginably cheap."

Ms Bien adds that financially savvy landlords will put aside the money they have saved on the mortgage to reduce the LTV on the property, or use it as a deposit when the time is right to expand their portfolio.

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