FORWHAT IT’SWORTH:RENTSANDVALUES

WordsbyJoeMcGrath

Departing landlords, rising rental demand, slowing house price growth and higher sustainability demands are presenting a unique set of considerations for BTL valuations this year

The final months of 2022 created a fascinating landscape for BTL valuations. While property price growth was slowing, rents were rocketing.

According to Zoopla, house price growth slowed considerably in H2 2022 and prices are predicted to fall in H1 2023. At the same time, large numbers of landlords quit the BTL sector at the end of last year, following the withdrawal of mortgage tax relief and the end of the government’s stamp duty holiday. This resulted in fewer properties on the market and higher rents.

These two trends matter in the world of BTL, because residential properties are typically valued in two ways: first, you have the market value, which surveyors assess by considering local sales activity for similar properties. This allows a surveyor to weigh up the supply and demand in the vicinity.

Second, there is the investment valuation, which is based on the asset’s rental value. This is informed by appetite in the local area at the date of valuation. It is important to note that a slower buyers’ market does not necessarily equate to a quieter rental one.

“The market value of any property should reflect the price achievable on the valuation date and, naturally, this will fluctuate depending upon market conditions, demand, sentiment and availability of finance,” says Andrew Murdoch, valuation panel director at VAS Valuation Group.

On top of this are factors such as the property’s condition, layout, fittings and improvements required. Compounding this is the issue of planning. For HMOs or properties that could be converted into one, having planning consent for this has a core influence on the property’s valuation.

A BTL C3 property—a regular flat or house—with permission for use class C4 (HMO) may be seen as more attractive to a prospective investor, resulting in a higher valuation. Generally, you can convert a C3 property into a C4 without a planning permission—as this falls under permitted development rights. However, it is still recommended to obtain a Lawful Development Certificate to formally confirm the change of use is classed as a permitted development. In short, it pays to have the paperwork.

Nonetheless, there are few hard and fast rules in BTL property valuation, with the lender and surveyor each having a subjective sway in the overall outcome— and asset owners can be dissatisfied if the final value falls short of what they had hoped for, notes Andrew.

“It is natural for owners to have an optimistic view of their property’s market value and be disappointed if the reported value does not reflect their opinion,” he says. “However, a valuer has to provide an independent opinion to the lender that reflects current market conditions.”

Remote inspection

To ensure their valuations are reliable, surveyors have been embracing technology and harnessing new methods to protect client service levels and maintain precision. Being able to provide accuracy and speed together is becoming increasingly important given recent market fluctuations.

Simon Jackson, managing director at SDL Surveying, explains that the valuation of BTL property has evolved with advances in data and technology, and also reflects recent upgrades to legislation on property safety and standards. In September 2022, the government issued its Decent Homes Standard consultation, with the aim of improving privately rented housing. It outlines what tenants can expect in terms of conditions, state of repair and facilities within a property.

Simon notes that not all surveys are done on site: “Many BTL properties are still inspected in person, but if the property is a standard type and adequate data exists, then a lender may sometimes request a desktop assessment, or obtain an automated valuation model (AVM), where capital and rental values are calculated by the algorithm, with no physical inspection carried out.”

Typically, desktop valuations—which are carried out by surveyors—are based on data and photographs. Historically, these have not been common in the BTL space, but are starting to be used for cases with lower LTVs. “Both of these methods of valuation are typically quicker than a traditional inspected valuation, although they are less likely to identify defects or issues with the structure of the property,” Simon says, which potentially runs the risk of additional costs down the line.

The uptick in desktop valuations has been one of the most significant developments in recent years, says Ben Culley, property risk manager at Aldermore. He comments that new technologies such as AVMs played “an especially vital role during the coronavirus pandemic”, when physical valuations were temporarily stopped by government restrictions.

In the wake of the pandemic, the remote approach has remained, Ben says. Photo- assisted desktop valuations, where owners provide photographs to the valuer as part of the assessment, “continue to be explored” and he expects to see “greater use” of this over the coming years. For example, companies are already carrying out roof inspections using drones. “Lenders have traditionally relied on physical inspections for BTL applications; however, following the increased use of desktop valuations and with the wealth of data available, more are now using or exploring the use of nonphysical assessments for BTL properties.”

When to be wary

The speed of an AVM or desktop valuation is important in a market that is fluctuating, especially when compared to the time taken for a full inspection. Nonetheless, there are limitations, according to Helen Scorer, operations director at Pure Panel Management. “An AVM gives an average price for a wide variety of property styles, sizes and conditions, but it may not take into account positive changes to the property, such as extensions or new fittings, as well as negatives, such as defects.”

Helen says surveyors are especially wary when data sets relating to the property are old or not up to date. “In a physical valuation, the surveyor will be looking at the condition of the comparable evidence and matching it with the subject property to produce a more accurate figure,” she explains. “Most importantly, a physical inspection of the property will highlight significant defects to help protect the lender from a risk perspective.”

Energy efficiency is critical

An additional headache landlords are dealing with is the government proposal to increase the minimum EPC rating for residential BTL properties to C.

“It’s a bit of an unknown,” states Peter Greig, head of real estate at OSB Group. “We think we know the direction of travel, but the government is yet to confirm the timeline. Landlords will not want to go investing earlier than they need to because of possible impacts on their margin. At the same time, landlords won’t want to leave it too late as spreading the cost might be more palatable—plus resources may become limited closer to the deadline. Landlords are also very aware of the costs currently being faced by their tenants, so they will be looking at making changes to help their tenants and have better-rated stock which could remove some of that risk element.”

John Baguley, director of technical, risk and compliance at Countrywide Surveying Services, explains that understanding the energy efficiency rating of each asset is now crucial. By not knowing, BTL investors risk owning assets “unsuitable for BTL within a couple of years”, he warns. “The EPC itself has limitations, and its reliability continues to be questioned. But, as it is the established mechanism by which to assess a property, it’s the benchmark to which we must operate.”

Essentially, landlords will need to factor in how much they need to spend on bringing new properties up to the proposed minimum standards, as well as updating their existing stock. “This is going to be a costly exercise and is likely to have an impact on the whole sector in terms of rents, yields and future investments,” Helen adds.

Greener home, higher rent

With tenants and buyers also becoming increasingly aware of the energy efficiency profile of properties and seeking buildings that perform well, John claims this is starting to translate to better rents and values, with landlords tapping into tenants’ desire for energy efficiency alongside the value that this can add to the property.

Research by Shawbrook Bank found that 58% of tenants would be less likely to consider a property with an EPC rating of D or below—a fact that has spurred more than half of landlords to make energy-efficiency improvements in the six months up to October 2022. These views are echoed by Douglas Lloyd, head of lettings and associate director at Finders Keepers, an Oxfordshire-based management agency, who says that tenants are becoming discerning due to the rising cost of energy prices and overall cost-of-living pressures facing Britons.

“It is highly topical. If you have two identical properties and one is energy efficiency rated A and the other is C, they are going to go for A,” he states. “In Oxford, people are very mindful of it. We have a development that has an Archimedes screw—a turbine that can generate its own electricity. That is a huge selling point for any tenant.”

Residential assets with an A+ rating, such as the one noted above, remain relatively rare and have had limited effects on BTL valuations to date. However, that is starting to change; Simon believes the market could look very different in the near future: “We are likely to see increased rents for more energy-efficient homes and, potentially, those below a certain standard will not be eligible for the rental market.”

For BTL investors, there is a case to be made for green premiums existing within the valuation process. Analysis by Knight Frank found that a 3% premium could be added to homes that have moved from an D to a C rating. Based on average resale values, this equates to a little over £9,000.

It is in homes with a large degree of improvement where the greatest premiums can be seen. A home moving two bands from an E to a C can expect an uplift in value of 8.8%, while those moving from an F/G can gain an additional 19.6%. However, it remains unclear if—and how—this is translated to the BTL valuation process.

Rents vs prices

Despite the effects of sustainability trends, surveyors agree that house price growth is likely to remain muted during the first half of 2023, although rental demand is expected to increase.

“More people will be looking to rent properties,” says Sophie Naessens, a valuation panel manager at OSB Group. “People are more clued up and will be looking for landlords who can meet their expectations. The rental market will be buoyant, but the stock will have to move with that too. If landlords don’t invest in their properties, those properties will likely fall away.”

While challenging market characteristics are expected to force further innovation in valuation methods, approaches will remain “an art and not a science,” according to Andrew. “Getting a local, experienced professional to inspect the property and value based on their vast experience will still be needed to protect a lender and make sure they are lending off accurate values.”