‘Guaranteed rent’ - the name alone is a compelling pitch.
With lower demand for rental properties in the UK’s major cities, and job losses and financial insecurity rising due to the pandemic, landlords are increasingly worried about the prospect of lengthy voids and rental arrears. This is driving a surge of interest in guaranteed rent schemes and their purported benefits, with providers claiming to offer a regular guaranteed rental income and eliminate the risk to landlords from voids, arrears, and evictions.
But what are these schemes and how do they work? How do operators deliver the benefits they promise and at what cost? In this article, we examine the ins and outs of rent-to-rent arrangements and perform a cost/benefit analysis for curious landlords.
What is a guaranteed rent scheme?
Under a guaranteed rent scheme, also known as a rent-to-rent scheme, a landlord signs over their rental property to a company, institution, letting agent, or individual for a specified period of time in exchange for a guaranteed monthly income (regardless of whether or not the property is occupied or if the tenants are in arrears).
The individual or organisation renting the property from the landlord then sublets the property to tenants and manages the property and tenancy. The renters who occupy the property have no direct relationship with the landlord, and everything is handled by the middle tenant.
How do these schemes work?
In a rent-to-rent arrangement, the middle tenant signs a contract guaranteeing to pay a set monthly income to the landlords in return for taking full control of the property and its management. The middle tenant will market the property to find renters, do all of the tenancy administration, handle any property maintenance, ensure that the property is compliant with all relevant legal requirements, and take care of legal proceedings in the event that the renters living in the property need to be evicted.
The middle tenant agrees a guaranteed monthly rent with the landlord that is below market value for the property. The success of their enterprise then rests on their ability to achieve a high enough rental income from the property to cover expenses and generate a profit. This is often only possible by converting a multi-bedroom property into an HMO and earning a higher yield by doing several single-room lets to multiple unrelated tenants with individual contracts.
Who offers them?
They are operated by both public and private sector organisations.
Many councils, particularly in areas where demand for housing is exceptionally high, offer these schemes as a way to increase their supply of social housing stock. Under an arrangement with a local authority, the council will become your ‘tenant’ and use the property to provide accommodation for those in need of social housing, e.g. refugees, the homeless, those who qualify for council tenancies.
In return, landlords receive a guaranteed monthly rental payment (often paid one month in advance) during the lease period even if the property is vacant, professional property management and regular inspections, and guaranteed vacant possession at the end of the lease.
Many local authorities also outsource this work to intermediary agents who communicate directly with private landlords and take care of property management and maintenance on their behalf. Landlords who lease directly to a council will normally need to provide their own compliance documentation and ensure that their property meets certain quality standards prior to entering into an agreement. By contrast, those who go through a private facilitating agent will normally have this taken care of as part of the terms of service with the management company.
For an example of a local authority guaranteed rent scheme, you can find the details for the Lewisham scheme here.
Lettings agents or dedicated rent-to-rent providers
There are many lettings agents (usually smaller or independent chains) and guaranteed rent services available on the market that offer commercial rent-to-rent arrangements. Unlike council-run schemes, these are for-profit services that source tenants from the private rented sector via conventional property marketing channels.
During the term of the lease, an agent will normally agree to take care of absolutely everything regarding property management, maintenance, and compliance, while also occasionally offering further complementary services such as interior design and redecoration. The agent essentially assumes total control over the asset for the agreed period of time in exchange for a monthly payment guarantee.
What is the difference between a guaranteed rent scheme and rent guarantee insurance?
Rent guarantee insurance is a type of landlord insurance that will pay out if your tenants fall into arrears. Many policies also include coverage for legal fees incurred if eviction proceedings are required to regain vacant possession. Policies are purchased at the start of a tenancy and provide insurance to landlords who have assured-shorthold tenancies, i.e there is some form of direct relationship between the landlord and tenant even if the landlord instructs a property manager.
In a guaranteed rent scheme, the landlord has no direct relationship with the occupier and the middle tenant is liable for making the rental payments regardless of whether the property is vacant or the renter living there is in arrears. The middle tenant is also responsible for recovering arrears and regaining vacant possession from their subtenant.
What are the benefits?
There are several reasons why landlords are growing increasingly interested in the rent-to-rent alternative:
- it’s the most ‘hands-off’ option available for landlords with no time or inclination to be involved in any part of the lettings process
- it ensures that there is a regular, predictable cash flow and less risk of dealing with arrears
- there is less risk of having to enter legal eviction proceedings
- less risk of having to deal with damage and repairs
- local authorities are among the most reliable ‘tenants’ a landlord can find
- if a property is leased through a local authority, the landlord will be helping to provide housing for those most vulnerable and in need - which represents a huge positive contribution to the local community
- landlords receive payment from the middle tenant even when the property is unoccupied, meaning there are no void periods for the landlord
The value proposition of guaranteed rent schemes can be particularly enticing for landlords with prior experience of arrears and evictions. However, though it is an understandably appealing option for anyone who has dealt with the stress of a nightmare tenancy, these schemes are by no means the ‘no risk’ failsafe lettings alternative that providers claim they are, as we shall discuss below.
What are the risks and drawbacks?
Though providers promise to spare landlords the trouble of dealing with voids, arrears, and eviction, significant pitfalls remain for any landlord entering a commercial rent-to-rent arrangement.
Ongoing legal liability
Though part of the rent-to-rent proposition's appeal lies in the promise of providing a rental income while relieving the landlord of their responsibilities, it’s not necessarily so straightforward. Regardless of whether or not compliance has been signed off to a third party, the landlord often remains on the hook. If the property becomes an unlicensed HMO, becomes overcrowded, isn’t fire or gas safe etc., the landlord can still be fined by the local authority.
Contracts that aren’t fit for purpose
Many landlords and rent-to-rent operators fall into the trap of using the wrong type of contract for the nature of their agreement. The only proper way to enter into a rent-to-rent agreement with an agent who intends to sublet your property is to draw up a commercial lease.
A common mistake made by agents is to enter into an AST (a type of tenancy with a strict legal definition that can only be used where the tenant is actually living in the property) with the landlord and issue licences to the subtenants. This is incorrect, and an AST contract will contain several irrelevant clauses while not addressing many of the most important conditions of your commercial arrangement.
As with any legal contract, it’s essential to read any agreements very carefully before entering into the lease. The contract should state clearly:
- who is responsible for maintenance and repairs
- who is responsible for arranging the relevant compliance documentation
- the term of the agreement
- the amount of rent that is guaranteed
- the terms according to which the lease might be renewed or terminated
- the mechanism of redress if the middle tenant fails to honour the rent guarantee
If you are entering into a private rent-to-rent arrangement, the safest option is to seek professional legal advice and have a qualified professional review the contract before you sign.
Invalidating the terms of your mortgage, head lease, or insurance policy
Before agreeing to terms with any agent, landlords should check the terms of their mortgage, head lease, and insurance policies. It is often the case that a mortgage provider or freeholder will only grant permission to let your property subject to certain conditions (e.g. a provider might only permit you to enter an assured shorthold tenancy with minimum and/or maximum term lengths). Similarly, it’s highly likely that your landlord’s insurance does not cover rent-to-rent arrangements (the likelihood of property damage or other incidents for which the policy would be required to pay out is far higher with more tenant turnover).
If you don’t confirm with the relevant providers that you have permission to use a guaranteed rent scheme to let your property, it’s very easy to find yourself in a lot of trouble down the line.
The company doesn’t have the financial resources or inclination to honour the guarantee
Companies have limited liability, and many agents and services offering guaranteed rent schemes are small businesses or individual investors with little financial backing. If the company cannot let the property at a high enough monthly rent, or the property remains unoccupied for long periods of time, there’s a real risk that they won’t be able to meet your guaranteed monthly rental payments.
If something were to go wrong with the rent-to-rent arrangement, or the company were to go bust, it can be even more difficult to regain control of your property than if it were necessary to evict live-in tenants. If the agent is liquidated then the tenancy agreement becomes void, and the landlord can issue a notice of eviction to the subtenants. However, if the middle tenant goes into administration and continues to trade, the subtenants can resist court proceedings to evict by claiming for ‘relief of forfeiture.’ In either case, matters are complicated by the fact that the landlord and subtenants do not have any direct relationship.
If the middle tenant is receiving rent from the subtenant but not paying the guaranteed monthly sum to the landlord, the landlord has to take legal action against the company. No tenancy is ever risk free and, while it may seem like the more secure option, these schemes come loaded with the potential to end in a different kind of nightmare scenario. For example, London Housing Solutions - a rent-to-rent company that specialised leasing properties from private landlords to let to LHA tenants - went bust and over £400k in rental payments ‘disappeared’, with money owed to more than 100 landlords.
The best way to mitigate risk is to either lease your property directly to a local authority for use as social housing, or to do extensive due diligence prior to entering into any agreement with a private company.
You should look for signs of robust financial health (which can be found by looking at their published accounts on Companies House), evidence that they have a long history of successfully operating rent-to-rent lets, and plenty of credible customer testimonials. It’s also important to only work with providers who can demonstrate membership of a relevant industry Ombudsman service (such as the Property Redress Scheme) and a recognised client money protection scheme.
How much does it cost?
It’s not easy to offer a definitive answer to this question, as there is little transparent pricing information available anywhere when it comes to guaranteed rent schemes. Most private companies running rent-to-rent services state that they charge 0% commission and that there won’t be any up front payments.
These companies aren’t taking on properties and subletting them for free - their profit comes from the difference between the guaranteed payment they agree with the landlord and the monthly rent they achieve on the market (less expenses). The exact size of the discrepancy is difficult to tell, but with the cost of compliance, property marketing, and maintenance running into potentially thousands of pounds, along with the standing costs incurred during void periods, the margin has to be large enough to cover fees and generate a profit.
Many companies are open about the fact that you are trading in your potential profit in exchange for the stability of guaranteed payments - they’re taking on all of the risk, so they’re also reaping most of the rewards. Just because they’re charging 0% commission and no admin fees doesn’t mean that you aren’t paying for this in other ways.
With the deductions they make from the monthly income your property generates, you are essentially paying for their expenses and covering your own void periods over the lifetime of your lease with the middle tenant. The total sum in rent you receive under this arrangement will be significantly lower than what you can achieve through a direct tenancy.
The extent to which this matters depends on your personal circumstances and investment objectives. If you have no mortgage to pay and no interest in being a hands on landlord, then the reliable cash flow and freedom from the legal and administrative responsibilities of managing a tenancy might mean that leasing to a middle tenant is a great option for you. Similarly, if you don’t rely on monthly rent as your primary source of income and simply want to pay off your mortgage, then exchanging in the potential for greater returns for stable cash flow could be a worthwhile trade-off.
However, if you’re looking to generate the best possible return on your buy-to-let investment then you won’t achieve your objectives with guaranteed rent. The business model underpinning this service only works where landlords are willing to sacrifice most of their potential profit margin. To get the most of your asset, you will need to let your property directly to the occupying tenants while finding alternative ways to cut costs and mitigate risks.
It’s also worth bearing in mind that, with robust affordability requirements and thorough referencing, it is very unlikely that your tenants will run up arrears or need to be removed from your property through eviction proceedings. With enough due diligence at the outset of a tenancy, many of the major risks for landlords associated with a tenancy can be mitigated so effectively that it isn’t worth surrendering so much value to the middle tenant for the sake of theoretical security.
What are my alternatives?
If your objective is to maximise revenue, minimise the risk of voids and arrears, and keep a healthy distance from day-to-day tenancy operations, the best solution is a combination of professional property management and rent guarantee insurance.
The resurgence of interest in guaranteed rent schemes can probably be at least partially explained by the lack of trust in traditional agents. This is understandable, as the industry is notorious for charging extortionate fees and offering substandard service.
However, Home Made is a proptech that is changing the process of letting a property. Using our proprietary technology and data-driven approach to marketing, we have drastically reduced the time it takes to let a property at only a fraction of the cost of a traditional agent. Our median time to let after a property is listed is just 8 days, so landlords don’t need to worry about lengthy void periods when working with us.
We offer completely transparent service with our online platform, giving our clients full visibility of the entire process, including the number of clicks on a listing, the number of viewings completed at your property, and where we are at every stage of the administration process.
With our recently revamped property management service, we’ll manage the full tenancy cycle from marketing to termination, with renewals included at no extra cost, taking the burden off your shoulders while still keeping you in the loop. Crucially, you remain in charge of what happens at your property - we won’t arrange any works without your approval or rent to anyone unless you are comfortable with them.
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