Implementing Rent Caps – Lender Consent Issues

This article considers the things Registered Provider (RP) treasury teams should be thinking about in relation to the recently announced rent cap.

Rental increases in England will be capped at 7% for social and affordable rent tenants for the next financial year 2023/24.

RPs in England are required to set social rents by reference to a statutory formula in accordance with the Rent Standard and affordable rents no more than 80% of market rent, inclusive of service charges. Rent increases are usually applied in April, and since April 2020 the increase has been capped at the Consumer Price Index (CPI) in September of the previous year plus 1%. This policy was due to continue for at least 5 years. However, CPI has risen exponentially in the last 12 months, reaching 10.1% in September 2022, so the Government has stepped in to cap rent increases for 2023/24 to no more than 7%.

The preceding consultation by the Department for Levelling Up, Housing and Communities (DLUHC) indicated a Government preference to introduce a tighter cap of 5%, while suggesting 3% and 7% as alternatives. The 7% cap represented a more favourable outcome than anticipated by many for RP balance sheets.

The cap for social and affordable rent will be implemented through a revised version of the Rent Standard. Alongside the consultation, DLUHC published a mark-up showing the proposed amendments to its current Policy Statement on Rents for Social Housing (Policy Statement). We still await a finalised version to know whether the details of the amended Rent Standard will be any different (as well as crucial information about exemptions from the cap, including for supported housing). However, based on the draft and the Autumn Statement:

  • The 7% cap on rental increases applies to social rent and affordable (i.e. 80% of market) rent for a temporary period from April 2023 to March 2024;
  • The Policy Statement says RPs must “endeavour” to apply the same cap on increases to the applicable service charges in the same period;
  • No RP is required to charge the maximum increase and they will still have the flexibility to apply a lower increase, or to freeze or reduce rents, should they wish to do so, based on local factors and as business plans allow, but always ensuring ongoing financial viability and compliance with the Regulatory Framework;
  • Rents for new social housing tenancies are not subject to the 7% cap. These will continue to increase- for example, with new affordable rent tenancies being let at 80% of the assessed market rent at that time; and
  • Supported housing tenancies are outside the scope of the cap and so RPs will still be permitted to apply a CPI+1% increase.

Funder issues

1. No lender consent for the mandatory cap for social and affordable rent properties: The change from CPI+1% to a straight 7% cap on rent increases for social and affordable rent properties will be implemented not via an amendment to tenancy agreements but through a statutory direction and will thereafter be set out in the Rent Standard. Annual rent reviews that comply with the Regulatory Framework are permitted and provided for as a standard term in each social housing/affordable housing tenancy agreement. Therefore, we would not expect these annual rent increases (albeit subject to a lower cap than under the current version of the Rent Standard) to trigger lender consent requirements, as loan, private placement and bond funding agreements invariably allow RPs to enter into tenancy agreements which comply with the Regulatory Framework or any other guidance issued by the Social Housing Regulator (which would include the Rent Standard).

2. Shared ownership leases: The Rent Standard does not apply to shared ownership leases and various other exempt categories of tenure. However, the NHF have announced a voluntary rent cap for its members on their shared ownership rents of 7% (a Voluntary Cap).

In a shared ownership lease, the annual rent review provisions specify the amount of the annual increase. For example, in the model form of lease that was issued under the 2016 – 2021 Shared Ownership and Affordable Homes Programme, rent is increased annually based on an uplift of 0.5% to RPI. RPI was 12.6% in September 2022. Therefore, a variation of the lease or other arrangement will be needed in order to apply the alternative Voluntary Cap.

If RPs decide to apply the Voluntary Cap in their shared ownership leases, it is likely to be applied in one of the following ways:

    • Apply a rent increase equal to the Voluntary Cap; or
    • Increase the rent in line with the lease but with an element of “forbearance”, where the RP only seeks to recoup the Voluntary Cap amount for 2023/24 (and potentially future financial years).

In either case, RPs need to think about whether consent will be required from their funders, where shared ownership properties are charged as security.

This will clearly depend on the provisions of the relevant funding agreements and related legal mortgages.

We have reviewed a number of funding agreements and legal mortgages that our clients have entered into recently. Typically, the mortgage requires the RP borrower to “enforce and not waive or release the covenants, conditions, agreements and obligations” contained in the relevant lease in any way “which materially adversely affects or is reasonably likely to materially adversely affect the value of the charged property”.

Typically, there is also a restriction in the mortgage on varying or altering the lease documents if those variations or alterations “materially adversely affect or are reasonably likely to materially adversely affect the value of the charged property”.

Therefore, in these cases, the question as to whether or not lender/bond trustee consent is required will come down to whether there will be a material and adverse impact on the value of the relevant properties.

The term “material and adverse” is not typically defined and therefore is subjective as to its interpretation.

In practice, we suspect that lenders would only deem a reduction in value to be “material and adverse” if it resulted in a breach of the asset cover covenant in the relevant funding agreement.

Under a typical funding agreement, an RP borrower is required to deliver full valuations of the charged properties every three or five years. Some agreements also require the borrower to deliver desktop valuations annually.

Lenders often also have the right to call for a valuation at any other time. The cost of that valuation (if it is outside the standard cycle) is only payable by the borrower if that valuation would show a breach of the asset cover covenant or any other event of default. If the valuation didn’t show a breach, the cost of the valuation will be borne by the lender.

Given the risk of lenders having to bear the cost of any one-off valuations, they are more unlikely to request one is carried out.

If a valuation isn’t obtained, it would be difficult for a lender to conclude that there had been a material and adverse effect on the value of the charged properties.

Even if a valuation was requested by a lender, any breach of the asset cover covenant could quickly and easily be rectified by either charging cash or further properties to rectify any breach.

Given the level of subjectivity as to what is meant by a “material and adverse” impact on property values, without a new valuation, RPs may conclude that consent is not required from their lenders, in circumstances where their mortgages contain the above provisions.

3. Financial support: Most loan agreements to RPs contain a restriction on them giving credit or financial support, including loans and credit to tenants outside the usual course of an RP’s business.

The terms “financial support” and “credit” are not typically defined anywhere.

This financial support clause was primarily introduced into loan agreements a few years ago, to restrict RPs using their cash and/or balance sheet to fund/support diverse activities elsewhere within an RP’s group.

It was not introduced with a view to controlling rent levels. If that was the intention, the clause would have been designed very differently.

In our view, it is likely to be possible for the majority of RPs to conclude that applying the Voluntary Cap does not constitute “financial support” or “credit” for the purposes of these clauses or that in doing so (particularly in light of the NHF’s announcement and the implementation of the rent caps for social and affordable rents), this would fall within the usual course of an RP’s business.

4. Practical Steps for RPs to take: We would recommend that RPs take the following steps in relation to their funding agreements:

(a) Check your funding agreements and mortgages (i) to ensure that there are no absolute consent rights for lenders in relation to the amendment/alteration of leases or a failure to enforce all of the provisions of a lease ie that the relevant clauses are qualified by the “material and adverse” affect on value referred to above and (ii) to establish the lenders’ rights to call for valuations;

(b) Consider notifying your lenders that you will be applying the Voluntary Cap, but don’t seek their consent (provided there are no absolute consent rights for lenders in relation to the amendment/ alteration of leases or a failure to enforce all of the provisions of a lease); and

(c) Carefully monitor compliance with the asset cover covenant, particularly where new valuations are due to be provided to lenders over the course of the next 15 months or so- if there may be a reduction in property values that could lead to a breach of the asset cover covenant, be prepared to either charge cash or further properties at short notice, to ensure there is no breach of the covenant.

If you would like to discuss these points, please get in touch with Julian Barker, Gary Grigor, Alice Overton or your usual Devonshires contact.

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