A Guide to HMO Investments
Whilst many investors are familiar with HMO properties, a surprising number are unaware of the huge advantages, especially financial, that such properties can afford. Demand remains high, particularly in university towns, where HMOs continue to be the property of choice for students looking to live with friends. Yet with the introduction of new legislation affecting everything from stamp duty to tenants fees, some investors are reluctant to put money into such properties. We’ve compiled this guide to HMO investment, which we hope will allow potential investors to weigh up the pros and cons of HMO investment.
What is a HMO?
An HMO, or house of multiple occupation, is a property inhabited by three or more tenants who share bathroom and kitchen facilities. These tenants cannot be related through blood or marriage.
What are the pros and cons of HMO investment?
The advantages of investing in HMOs are numerous, though perhaps the most obvious one is the higher yields available when compared to single-let properties. This is best illustrated by research undertaken by GVA Redilco, which found that HMO properties had a yield of 7.1% in the first half of 2018, a figure which far outstripped the property investment sector average of 5.8%.
In a single-let property, income dries up if a tenant moves out or fails to make a payment. Here, again, an HMO property has its advantages. Risk is spread, and there is more than one source of income available. Even in the smallest HMO property, if one tenant moves out, two-thirds of the investor’s income remains safe. This is particularly useful for investors who rely on the income they acquire through HMO ownership, and makes an HMO an excellent option for those just starting out in the world of investment.
Other financial advantages of HMO ownership occur in the form of tax breaks. In contrast to conventional BTL properties, landlords of HMO properties can claim ‘Plant and Machinery Capital Allowances’. Through this method of tax relief, a proportion of capital improvement and purchase expenditure is treated as an outlay for the rental business. Investors may offset these Allowances against non-property income. This is not permitted for ordinary rental losses, which may only be offset against future rental profits. This can lead to tax rebates worth potentially thousands of pounds.
There is also no shortage of demand for HMOs. The number of students currently in university, the group with the lowest average income, is at a record high, and it is thought that disposable income levels have only been lower twice in the past twenty years. It therefore comes as little surprise that demand for HMOs rose by 100% in 2017 and by an astonishing 150% three years ago. This trend is surely set to continue.
Although the advantages of investment in HMO property are undeniable, any potential investor should also be aware of the risks and disadvantages associated with the sector. This primarily takes the form of new legislation, introduced late last year, which is thought to have affected at least 177,000 properties nationwide. Prior to the new law’s introduction, compulsory licencing was only applied to larger HMO properties, with five occupants spread over at least three stories. Now however, a greater range of Buy-To-Let (BTL) properties have been brought under the licencing’s remit, including blocks of flats not connected to commercial premises and flats above shops. Further, standardised minimum measurements for rooms have been introduced. These will be under constant scrutiny by council officials.
Legislation was also introduced in 2016 which established stamp duty tax at a rate of 3% on second homes and HMO properties. Tax relief on mortgage interest, which has been phased out over the past three years, has also had a major impact on investors in the sector.
Potential investors should also be aware that legislation is aso stricter for HMOs than single-let properties. For example, in some areas, the law requires that any investor who purchases a property must seek planning permission prior to converting a single-let into an HMO, a process which can be both lengthy and costly, with no guarantee that permission will be granted.
Thanks to this legislation, it has become increasingly difficult for investors to acquire suitable, eligible, HMO properties, and competition for those which remain is fierce. Supply cannot keep up with demand, and has led to a sharp increase in prices. Further, raising sufficient capital for a purchase has been made more difficult thanks to the Bank of England’s concern over the risk posed by HMO properties to the UK economy. Lenders have enforced harsher criteria on borrowing, and it is expected that deposits necessary for mortgages will also increase soon.
What makes a good HMO investment?
It is vital that any property purchased for HMO investment satisfies the regulations implemented by the government and local councils. As has been stated above, minimum size requirements for rooms are particularly strict. Single bedrooms must be at least 6.51 square metres, whilst doubles sleeping two adults must be 10.22 square metres. When purchasing a property for HMO conversion, the investor should ensure that all the rooms in the property are large enough, and that large-scale, expensive work is not necessary.
The investor should also consider the size of the property. Small HMOs are defined as those with three or four tenants. An investor could purchase a three bedroom house and rent these rooms separately. Planning permission for work on such a building would be easier to obtain than for larger buildings, with the result that the property can be listed on the market far more quickly. In such properties, the quality of living should in theory be better for tenants, as fewer individuals in a household leads to fewer disputes, with less chance of one tenant leaving a property. Further, fewer tenants means the likelihood of maintenance problems is dramatically reduced.
Larger HMOs also have their advantages and disadvantages. Obviously, a larger property will accommodate a greater number of tenants, and as a result, rental yields will be higher. Although operating costs and the initial purchase price will be higher, the increase in rental yield will offset this, as will the fact that there is less demand for large properties. Investors may find that there are better deals available for such properties than they might at first expect. In such properties, however, there may not be a sufficient number of bathroom and kitchen facilities to satisfy the needs of all clients. Potential investors should therefore take costs associated with refurbishment into account when making a purchase. Once tenants have been found for a larger HMO property, investors may find that the management of the property is harder than it would have been for a smaller building, as there are more potential maintenance issues, as well as a higher turnaround of tenants. It may therefore be more sensible financially to own a number of smaller properties rather than one large one. Although the purchase of a greater number of properties will be more expensive, the cost of conversion into HMOs will be lower. Investments will also be spread and therefore so too will risk.
Location is also a key factor in any investor’s decision to purchase an HMO property. It is well known, for example, that the North of the UK is currently experiencing economic growth at an astonishing rate. Employment opportunities have been created in the hubs of Manchester and Liverpool, and as more people move there, the demand for affordable property has increased rapidly. In the North West, potential rental yields are the highest in the country.
Investors should also consider which demographic they are targeting. University cities, and areas with a high demand for a low cost lifestyle are the perfect areas for such investment, as students and young people with a low level of disposable income are those most likely to choose to live in an HMO.
Investors should also ensure that they analyse the HMO market in the area in which they have chosen to invest. In particular, they ought to collect information on rental prices for similar properties. This allows the investor to calculate a rental price for their potential tenants which is competitive, yet still provides a suitable yield.
The quality of other HMOs should also be taken into consideration. Particularly successful established investors in the area may have a unique selling point; potential investors should look to these successes and establish their own selling point. For example, an investor may decide to offer a premium HMO, with a higher quality of furnishing, for which they can charge a higher rate of rent which still falls below the rate set for a more traditional BTL property.
At Mistoria, we can help you source the right HMO property for your needs, ensure regulatory compliance, carry out HMO conversion, and manage your tenants on your behalf. If you are considering investing with us, please complete our enquiry form here or call 0800 500 3015.