Investing in HMO property – what you need to know

By Ben Gosling of www.commercialtrust.co.uk

Find out everything what you need to know to invest in your first HMO property: the cash flow benefits, possible planning restrictions, licensing laws and how to obtain finance.

What is a house in multiple occupation?

The Housing Act 2004 gives us the current definition of a house in multiple occupation (HMO) – a property in which two or more paying tenants from separate households reside as their main or only residence and share one or more basic amenities (such as a kitchen or bathroom).

HMOs are popular with both students and single tenants, particularly professionals in urban areas who have yet to put down roots. Many such tenants find it more affordable and convenient to rent a single room rather than a self-contained flat or house, and this type of property is therefore in high demand.

Why invest in HMO property?

With a single let, a household will usually pay for between one and three bedrooms, a living space, and amenities. In an HMO, individual tenants will pay slightly less, but every bedroom tends to be utilised, and living spaces and amenities are shared. The multiple income streams from HMOs tend to outstrip single income streams from comparably-sized single-let properties.

Simply put, HMO properties have the potential to earn more. In January 2015, the Telegraph reported that the average HMO generated a 9% return on investment in Q4 2014, while a traditional buy to let earned 6.3%: www.telegraph.co.uk.

This follows a long-term trend that goes as far back as Q1 2011, and thanks to high demand from tenants for this type of property, experts foresee this performance continuing.

The HMO alternative: multi-unit freehold blocks (MUFBs)

The Telegraph article cited above also reported that, in the final quarter of 2014, rental yields on multi-unit freehold blocks were higher even than those on HMO properties.

MUFBs are buildings that are split into multiple self-contained dwellings that, unlike those in HMOs, do not share any facilities (though they may share common areas such as gardens and hallways).

Experts believe that the cash flow advantage of MUFBs is due to economies of scale (the cost benefits enjoyed by larger businesses) and therefore this type of property may be more appealing to higher-value investors. In addition, MUFBs may face tougher planning regulations and require more extensive development.

HMO renovation and planning permission

Landlords who intend to convert a property in order to let it out as an HMO may require planning permission to do so.

In planning law, HMOs fall under their own usage class – C4 – if they are let to no more than six individuals. Converting an ordinary residential property (class C3) to an HMO does not usually require planning permission.

However, local authorities have the power to revoke this permission by means of an Article 4 Direction if they wish to limit the number of HMOs in a particular area (www.landlords.org.uk).

In addition, HMOs that are let out to more than six tenants are considered sui generis (uncategorised), and will require planning permission to convert.

Landlords should therefore contact their local planning department in either case, in order to check whether their planned renovation will require planning permission.

More information: www.landlordsguild.com/do-i-need-planning-permission-for-my-hmo-2/

Renovation may require specialist finance

Not all buy to let lenders will finance properties that are in need of renovation, particularly if they are considered unfit for habitation (if they lack kitchen or sanitary facilities, for instance).

Some lenders, however, will offer specialised refurbishment mortgages that release the required funds in stages. Bridging finance can also be used to fund renovation projects.

This article that Commercial Trust previously provided for the Homes 24 blog examines renovation finance in more detail: Buying a dilapidated property: three funding options for renovation.

Some HMO properties require a license

In some cases, HMO properties are subject to licensing. Each property must have its own license.

In order to qualify for a license, landlords must ensure that the amenities in and size of their HMO are suitable for the number of people who will be living there. They must also prove themselves to their licensing authority to be ‘fit and proper’ to let out HMO properties, and abide by a number of other requirements as outlined in the link below:

www.gov.uk/house-in-multiple-occupation-licence

‘Large’ HMOs – those that are three or more storeys high and let to five or more people from at least two separate households – are subject to mandatory licensing. Some local authorities operate additional licensing schemes for smaller properties, however, so landlords should always contact their local authority to determine whether they will require a license.

New legislation may extend licensing to smaller properties

The government is currently consulting on whether to extend mandatory licensing to smaller properties, including one- and two-storey buildings that house five or more tenants.

Though not yet law, future legislation could well mirror the content of the consultation in one form or another. Landlords considering investing in an HMO property might therefore consider familiarising themselves with the proposals in order to ensure that their purchase continues to be compliant in the future.

The consultation will run until 18 December 2015. More information can be found on the government website: www.gov.uk/government/consultations/extending-mandatory-licensing-of-houses-in-multiple-occupation-and-related-reforms

HMO finance is harder to come by – but good deals are available

Because not all buy to let lenders will grant mortgages for houses in multiple occupation, it can be harder to find a mortgage for an HMO (particularly if it is subject to licensing). This means that rates may be slightly higher and a larger deposit may be required.

However, the shortage is far from chronic. A number of specialist lenders with dedicated HMO product ranges have come onto the market in the past few years, and it is quite possible to find a good deal.

In summary

Positives about HMO investment

  • Potentially higher rental yields
  • More cost-effective use of space
  • High demand from tenants

Negatives about HMO investment

  • More development work may be needed
  • Stricter legal requirements
  • It might be more difficult to obtain finance

A qualified buy to let mortgage advisor can help landlords secure the best available deal for their next HMO purchase.

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