Cost of Living (Tenant Protection) (Scotland) Act 2022 - 2nd proposed extension: statement of reasons

Annex F

Key updates to the Business Regulatory Impact Assessment (BRIA) and Financial Memorandum

1. This Annex discusses the impact of a further six month extension on key estimates which were set out in the Business Regulatory Impact Assessment (BRIA) and Financial Memorandum which accompanied the introduction of the Cost of Living (Tenant Protection) Bill, and which were updated in Annex D of the Statement of Reasons which accompanied the first six month extension.

2. In the BRIA/Financial Memorandum, it was estimated that in the absence of legislation around 55,000 private rented households may experience a rent increase over a six month period. This was based on an assumption that 50% of landlords would raise rents,^[39] applied to the number of tenancies (an estimated 110,000) where there would be an opportunity to raise rents in a six month period.^[40] High and low estimates were provided around this central estimate to reflect potential behaviour change by landlords given current economic conditions: the high estimate of 70% was designed to reflect the possibility that landlords may have been more likely than usual to increase rents due to the high level of inflation and increases in mortgage costs, and the low estimate of 30% to represent the possibility that landlords may have been slower than usual to increase rents due to the economic pressures on tenants, giving a range of 33,000 to 77,000.

3. The number of properties that will be affected by the six month extension from October 2023 to March 2024 depends not only on the share of landlords who wish to raise rents for sitting tenants, but also on how landlords have responded to the emergency legislation in previous periods. In the BRIA update accompanying the first extension, it was noted that landlords who would have wished to raise rents in the first period of the legislation from September 2022 to March 2023, but who were prevented from doing so due to the cap being set at 0%,^[41] may choose to raise rents in the period April to September 2023 when the general rent cap has increased to 3% and the cap for the alternative ground of increases in prescribed property costs to 6%. If they do raise rents during this period, and there is no further change in tenancy, these landlords will not be able to raise rents in the period October 2023 to March 2024 since under a Private Residential Tenancy the rent cannot be raised more than once in a 12 month period.

4. However, some landlords will have experienced a change of tenancy during the period September 2022 to March 2023. Assuming that landlords do not raise rents during the first 12 months of a tenancy (especially as the rent cap does not apply between tenancies, so landlords are free to increase rents at the point of new let), and assuming there has been no further change in tenancy, the landlord may wish to raise the rent when these new tenancies reach their 12 month anniversary during the period October 2023 to March 2024. There are an estimated 38,000 properties which fall into this category. This gives a range of between 38,000 properties and 110,000 properties where the landlord could raise the rent for a sitting tenant over the 6 months from October 2023 to March 2024. On the central assumption that 50% of landlords who can raise rents for sitting tenants in fact wish to do so, this gives a range of between 19,000 and 55,000 properties affected by the extension of the rent cap.^[42]

5. The amount of rent foregone by landlords will depend on what rent increase they would have been able to apply in the absence of this legislation. As set out earlier in this Statement of Reasons, the most recent data from letting agents relating to Q1 2023 suggests that new let rents in Scotland were growing by around 12% to 13% annually. However, during the course of 2023, inflation is projected to fall gradually, and this may similarly be reflected in rental trends. For example, Zoopla project that rental growth in the UK may ease towards 4%-5% by the end of 2023.^[43] Furthermore, the cap applies to rent increases for existing tenants, not new tenants, and the gap in average rent levels between existing and new tenants suggests that rent increases for existing tenants may typically be lower on average than increases between tenancies.

6. We therefore cost three scenarios relating to what rental growth for existing tenants would otherwise have been:

i. Rental growth of 3% or below – there will be no foregone rental income.

ii. Rental growth of 5% – with a permitted rent increase of 3%, the foregone rental growth is 2%.

iii. Rental growth of 10% – with a permitted rent increase of 3%, the foregone rental growth is 7%. This scenario is a very much an upper-end scenario, which assumes that new let rental growth continues at current elevated levels despite projected falls in inflation, and also assumes that rents on existing lets grow at the same rate as new let rents.

7. The impact of the rent growth cap is calculated using an average monthly rent of £736, which is most recently published average two bedroom rent (the most common size of privately rented property) in Scotland.^[44] This gives the following scenarios:

8. The next table presents estimates of foregone rental income across the private rental sector as whole. These estimates range between £1.0m and £23.8m, illustrating the uncertainties relating to future rental growth as well as to landlord behaviour, both in terms of whether they decide to increase rent for sitting tenants and also how they have previously responded to the emergency legislation.

9. Note that the tables above only give illustrative scenarios of the impact of increasing rents under the general 3% provision, and do not include the alternative ground to increase rents up to a maximum of 6% if prescribed property costs have increased. Where a landlord is able to increase rents under this ground, then the foregone revenue will be lower than presented in the above tables.

10. One type of prescribed property cost which has seen significant increases is mortgage costs,^[45] although in recent months fixed rate mortgage rates have moved down from their highs reached towards the end of 2022.^[46] However, landlords with fixed rate mortgages which reach the end of the fix period are likely to experience an increase in costs, since the period of the fix is generally at least two years. It is estimated that over the course of six months, there will be around 10,000 properties (around 3% of the total private rented stock) where a fixed rate mortgage reaches its end of term and there has been no change in tenant during the previous 12 months. It was previously estimated that the average increase in costs would be around £300 per month, but due to mortgage rates being below the peaks reached towards the end of 2022 it is more likely that the average increase will be in the £200 to £300 range.^[47]

11. Whether landlords with variable rate mortgages will be able to apply for an increase based on prescribed property costs will depend on whether variable rates continue to rise or whether they stabilise or fall in the six months prior to the landlord issuing a rent increase notice. It is estimated that around 10% of all private rented sector properties in Scotland have a variable rate mortgage. Given the estimated range set out in paragraph 4 of between 38,000 and 110,000 properties (depending on past landlord responses to the emergency legislation) where the landlord could raise the rent for the sitting tenant over the period of the second extension, this suggests that there will be between 3,800 and 11,100 such properties with a variable rate mortgage.^[48] Any increases in variable rate mortgage costs during the six months prior to rent increase notice being served are likely to be significantly smaller than increases in fixed rate mortgage costs during the corresponding period, since for fixed rate mortgages the comparison is with the mortgage rate at least two years ago.^[49] To give an idea of the potential magnitude of variable mortgage costs increases, each 0.25% point increase in the variable mortgage rate is estimated to increase variable mortgage costs by an average of around £20 per month, which is similar to a 3% increase in the average two-bedroom rent.^[50]

12. For properties with a fixed rate mortgage, an increase of £200 to £300 equates to around 30% to 40% of an average two-bed rent, but it should be borne in mind that:

Even in normal market conditions, a seller is unlikely to pass anywhere near a 100% of a cost increase onto buyers, since the market price is constrained by the buyers' responsiveness to price increases. In the current rental market, tenants are particularly affected by cost of living pressures, which will limit their ability to pay higher rents, and in turn limit how much the market rent can increase by.

This is particularly the case when very large cost pressures affect only a segment of the market, since the market rent is determined independently of an individual landlord's financing decisions since they will be competing with other landlords who have made different financing decisions.

13. As an illustration of the above considerations, data from Zoopla show that annual growth in new let rents in Scotland in October 2022, following the surge in mortgage rates after the UK Government mini-budget in September 2022, was 11.3%, well short of the increase in costs that might have been incurred by some landlords due to higher mortgage costs, despite new let rents being free to be set at market rates.

14. In terms of the number of applications that might be received by Rent Service Scotland for the 6% increase due to prescribed property costs, in the first two months of the April to September 2023 extension, 603 applications were received. If this rate continues, that would equate to around 1,809 applications for the full 6 month period, although it should be noted that applications in the beginning of the period could be boosted by landlords who chose not to put in an application in the first period of operation of the legislation, when the prescribed property costs cap was set at 3%. To the extent that this is the case, there could be a lower rate of applications in remaining months of the first period of extension, as well during the second period of extension from October 2023 to March 2023, especially if stabilisation/reduction in mortgage rates continues which means that landlords with variable mortgage rates do not make applications.

15. Tenants also have the right to refer a rent increase notice to a Rent Officer to verify whether a proposed rent increase is in line with the rent cap. From 1st April 2023 to 29 May 2023, Rent Service Scotland has received 16 tenant verification applications to confirm the 3% increase is in line with the legislation, which suggests that relatively few applications for this will be received.

16. The extension of the rent cap for a further 6 months may have an impact on certain incentives to invest. The incentive to invest in new supply will not be initially affected because the cap does not apply to new lets. Furthermore, as the legislation cannot be extended beyond 31 March 2024 at the latest, landlords of new units which are let for the first time after 31 March 2023 are unlikely to raise rents for sitting tenants during the period of operation of the legislation. There is a provision under the Act to amend the rent adjudication process after (or in anticipation of) the expiry of the rent cap to aid in the transition out of the emergency measures. Any proposed use of this power would be subject to stakeholder engagement and the approval of the Scottish Parliament. It is worth noting in this context that the latest data from the Scottish Landlord Register does not show any decrease in the number of properties registered over the period of the operation of the emergency legislation.^[51]

17. However, there is a degree of tension between protecting existing tenants and preserving incentives for landlords to invest in the quality of the property and continue to provide existing rental accommodation. The ONS produces estimates of the costs of regular repair and maintenance of a dwelling as part of the CPI. Annual growth in this series, which was 7.5% in September 2022, has decreased somewhat to 5.6% in March 2023. This increase relates to a portion of the landlord's total costs: data from HMRC show that for non-incorporated landlords in the UK, repairs and maintenance comprised 25% of total allowable expenses, and 12% of total income declared. In extending the protection for tenants for a further six months, the intention has been to ensure that any rent increases are sufficiently modest so that they do not impose significant additional pressure on tenant budgets while cost of living pressures remain acute (which will help them to sustain their tenancy), while allowing some uplift for landlords to help them meet any cost increases from maintaining properties to the required standard, from higher mortgage rates, or from other sources.