Day: September 2, 2023

This week the Scottish Government released the first statistics on applications and granting of licences for short-term lets by councils (write Fraser of Allander Institute’s JOAO SOUSA and MAIRI SPOWAGE).

The licensing scheme came into force in October 2022 for new operators, and existing operators must apply for a licence before 1 October 2023. We’ll explore a bit more about the expected outcomes from the scheme and what the data tell us so far:

What is the idea behind the licensing scheme?

The Scottish Government committed in the 2018-19 Programme for Government to create a system that would allow local authorities to have “appropriate regulatory powers to balance the needs and concerns of their communities with wider economic and tourism interests”. There have since been three consultations (2019, 2020 and 2021) on the desirability of a scheme and its aims, with a final statutory instrument being laid in late 2021 to implement the scheme now in place.

The licensing scheme is based on provisions from the Civic Government (Scotland) Act 1982, which allow the Scottish Government to make it a criminal offence for operators in specified markets to operate without a licence, making them subject to a fine of up to £2,500 (which the Government intends to legislate to increase to £10,000). There is also a provision for the designation of control areas by councils to manage high concentrations of secondary letting.

The Scottish Government’s stated aims in introducing the scheme are to:

• Ensure short-term lets are safe and address issues faced by neighbours;
• Allow local authorities to know and understand what activities are happening in their area, and to allow them to handle complaints effectively;
• Manage high concentration areas of secondary letting where it affects the availability of residential housing or the character of a neighbourhood);
• Restrict short-term lets in places where they deem it not appropriate; and
• Help local authorities ensure the available housing stock is used to the best effect.

The Scottish Parliament Information Centre (SPICe) has a helpful blog covering the specifics of the scheme and the legislative process that has underpinned it.

Why does the Government feel the need to intervene?

As part of the business and regulatory impact assessment (BRIA) process, the Scottish Government is required to justify why it feels that government intervention is appropriate. The rationale for intervention is generally a market failure, that is, a situation where market outcomes end up not being socially optimal – either because too much or too little activity happens and/or because costs are imposed on third parties that have no say in the transaction.

In the BRIA for this measure, the Scottish Government highlights two main market failures:

• One is asymmetric information, as hosts are likely to know more about the safety and quality of a property than guests. The classic example of this in the market for used cars (George Akerlof’s Nobel Prize-winning contribution), where the asymmetry means that eventually only poor quality cars are sold. In the short-term licensing case, the Government argues that people may unwittingly stay in unsafe accommodation and that unsafe hosts will undercut safe hosts because they will not have to bear the costs of meeting safety standards. The Government then argues that the licensing scheme will provide better information, removing unsafe accommodation and providing a level playing field – and also states that increased consumer confidence might increase demand for short-term lets.
• The other market failure described by the government is the existence of negative externalities, which mean that third parties (i.e. neither hosts nor guests) bear some of the costs of these transactions but such costs are not accounted for in the market price. The BRIA lists a number of those, including increased housing costs (to rent long term or buy) for local residents; the decrease in local amenities for long-term residents and reduced sense of community due to a high concentration of short-term lets; nuisance through noise, littering and anti-social behaviour; and potential use of accommodation for criminal purpose, with or without collusion from the host. Nuisance impacts (parking, littering, traffic and noise) were found in a 2019 survey by the Scottish Government to be a big concern, as were the impacts on the housing market through reduction in housing affordability through lower availability and higher prices for long-term residential use.

The effects on neighbourhood character, nuisance and the long-term residential housing market are especially prevalent in areas of very high concentration of short-term lets. Edinburgh City Centre and Skye are the most extreme cases, where the Scottish Government estimates that more than 10% of dwellings are used for secondary letting.

Who and what does licensing cover?

The licensing scheme casts a very wide net. It naturally applies to secondary letting – that is, the letting of a property that is not one’s main residence, so a second home or holiday let. But it also applies to those renting out a room in their property on a short-term basis while living in it, and those letting out a property while on holiday – including house swaps, even if no money is exchanged (as the legislation treats that as an in-kind payments and therefore still requiring licensing).

There are exemptions – for example, those providing a service (e.g. careworkers) while staying overnight, aparthotels and other types of accommodation (hotels, some B&Bs and guesthouses with licensed premises) which already have their own licensing scheme.

The scheme also imposes minimum safety standards, including meeting the repairing standard, providing an energy certificate, fire records and warning systems, gas supply certificates, electrical installation condition reports, portable appliance testing for all movable appliances, legionella risk assessment, and buildings and public liability insurance.

Councils are also allowed to set additional standards which go above those in the legislation. Operators will also have to pay a fee for obtaining the licence, which is to be set by local authorities on the basis of the cost they incur to administer the scheme. The SPICe blog mentions £300 to £500 as the expected level for these fees.

Is there evidence for these market failures and how well does the scheme address them?

There is some evidence in the BRIA that specific areas of Scotland have very high concentrations of short-term lets, and that such concentrations have reduce the supply of housing available for long-term residential use. This drives up prices and reduces affordability, and is especially true for second homes.

The scheme goes some way towards addressing this by imposing additional costs on secondary letting and allowing councils to set up control areas in which planning permission is required for letting out an entire second home. If the intended effect is to encourage some people at the margin who would otherwise keep letting out their second home to release it for long-term use, then it will have some effect.

It is, though, debatable how large that will be relative to the additional income earned through short-term letting. But the Government’s BRIA has made no attempt to quantify this – in fact, section E (which summaries costs and benefits) is notable for the absence of any quantification of impacts.

One clear effect of the scheme will be to increase the cost of supplying accommodation. Even if a host provides safe accommodation already, with all the formal requirements set out in the regulations, it will still have to bear the cost of the licence.

But it is unlikely that many will have no other additional costs. The question then becomes who bears these additional costs, and that depends mostly on the price elasticity of demand, that is, how price sensitive consumers are.

If guests are not very price sensitive, then we would expect them to bear most of the additional costs through higher prices, without much reduction in the quantity of accommodation purchased. But if they are very price sensitive, then more of the cost will be borne by suppliers – and if it tips some into not making a high enough return on supplying short-term accommodation, then they might exit the market altogether – leading to both higher prices and lower availability.

That may well be the Government’s intended outcome – but the BRIA does not make that clear. And by including those renting a room in their home while living there in the scheme, it’s not clear either that licensing will lead to the release of substantial amounts of property into residential use.

But rooms for short-term rental are substantially cheaper than whole dwelling accommodation, and hosts are likely to be earning considerably less – and given the fee and cost structure of complying, they are the most likely to decide not to supply short-term accommodation.

If that happens, we will be in a situation where supply is lower, prices are higher and little additional housing is available – because those most likely to exit the market were already using it for their main residence. The BRIA states that a visit to Scotland does not have a perfect substitute in visiting a different place, implying that the market would be able to bear higher prices – but that presumes that the prospective visitor has a very specific preference for visiting Scotland.

But no evidence is provided to back this up – and if consumers are instead indifferent about destinations and are instead shopping around given specific dates they have in place, their price sensitivity could be much greater.

The BRIA argues that the reduction in information asymmetry may in fact increase demand for accommodation in Scotland relative to competitor destinations. This is an unpersuasive argument.

Unlike other markets where little recourse exists – e.g. cash sales or small value items – there is a lot of information already in the market, including peer reviews on platforms which already require those reviewing to have previously purchased the service.

The platforms themselves have an incentive to maintain high quality as otherwise their reputation will suffer. And in any case in none of the consultation documents provide much evidence that the sector is currently providing much unsafe accommodation – bringing into question whether the market failure the scheme is meant to address is a significant one to begin with.

What does today’s statistics release tell us about the scheme?

Today’s release covered the first two quarters (Q4 2022 and Q1 2023) during which applications could be made for a licence, though only new operators were required to have applied already.

It is also hard to know the total number of potentially affected operators. The BRIA used the non-domestic rates valuation roll for premises registered for self-catering or B&B/guest house use, which amounted to around 18,000 in April 2021. But many of the properties covered will not be subject to non-domestic rates but instead council tax, as their main purpose is residential use. Airbnb had 35,000 properties available to let in Scotland in January 2019.

In any case, the number of applications received by 31 March 2023 was just over 2,500, indicating that probably less than a tenth of all eligible properties were in the system by then. Of the applications received, just over a third had received a decision, and not a single one had been refused. This is perhaps unsurprising at this stage – people who have already applied when compliance is only mandatory for new operators will be disproportionally likely to comply with the rules.

Numbers were especially low in urban areas: both Edinburgh and Glasgow had less than 100 applications each, and Aberdeen and Dundee had less than 50 each. With urban areas being much more likely to have home sharing, we probably should read little into the fact that the majority of applications so far have been for secondary letting of whole dwellings.

The low numbers in the system though could be something of a concern going forward. The scheme’s binding deadline was extended by six months to 1 October 2023 in December of last year, and while the First Minister has ruled out subsequent delays, local authorities might find themselves flooded with applications right before the deadline.

It also raises the issue of compliance with the scheme and of the public’s awareness of it. The Scottish Government has set up a website with information on how to comply, but given how few people have already applied, it might be required to step up its information campaign – we are not sure people are fully aware they are in theory committing a criminal offence if they do not apply for licence and continue operating.

Overall, whilst the policy imperative on second homes in some areas of Scotland is well evidenced, the breadth of this legislation to target use of primary residences seems much less so. Many will be surprised to find that it includes house swaps! It is not clear to us what policy problem the inclusion of this activity is actually trying to address.