An article written by Barry Searle, Managing Director, Property at Castle Trust Bank for Brightstar’s ezine.
A growing number of landlords are choosing to diversify their portfolio, from letting out property on a standard AST to investing in a house of multiple occupants (HMO). There’s a clear reason for doing this as HMOs can usually deliver stronger returns than a single let property. According to BuyAssociation, research from BVA BDRC shows the average rental yield for an HMO property is 7.5%, which is 1.5% above the overall average rental yield for property investments – or, put another way, a 25% uplift in yield
As well as the potential for stronger returns, earning rental income from multiple tenants means that landlords have less exposure to potential arrears than they would if they let the property to a single tenant – if one tenant is unable to pay or one room remains unlet for example, there is still the potential for income from other tenants. So, what do you need to know about HMOs to help your clients make the most of this opportunity?
Regulation and Licensing
An HMO is a property rented out by at least three people who are not from the same household but who share facilities like the bathroom and kitchen.
As of 1 October 2018, in England and Wales, a license is required to rent out any HMO if it is rented to five or more people who form more than one household, although in some cases a license may be required for a smaller property if the local authority requires one to be in place. Unfortunately, there is no central database that lists all of the licensing requirements for different areas and so investors need to check with the local authority in the area they intend to buy an HMO. New licensing schemes are being introduced all the time. In April this year, for example. 11 new schemes are coming into effect across the country, in local authorities including Ealing, Luton, Liverpool, Lewisham, Bristol, Charnwood, and Durham. Failure to comply and obtain the correct license can lead to fines of up to £30,000, so this is an important detail to which investors must pay close attention.
HMO licenses are issued by the local authority and are valid for a maximum of five years. The owner of a licensed HMO must make sure the house is suitable for the number of occupants and that the manager of the property, who could be the owner or an agent, is considered to be ‘fit and proper’. This excludes people with a criminal record or a previous breach of landlord laws or code of practice.
Owners must also send an updated gas safety certificate to the local authority every year, install and maintain smoke alarms and provide safety certificates for all electrical appliances when requested, as well as any other conditions imposed by the local authority.
The government has also introduced minimum room sizes for bedrooms in licensed HMOs, and any room that is used for sleeping accommodation must have a floor area of no less than 4.64 square metres. The full details of the minimum room sizes are:
Minimum sizes
- Single bedrooms to be used by one person over 10 years old should not be less than 6.51 square metres.
- A double bedroom to be used by two people over 10 years old should not be less than 10.22 square metres.
- Single bedrooms to be used by one person under 10 years old should not be less than 4.64 square metres.
Properties intended for use as a licensed HMO that have rooms smaller than the required dimensions may require renovations to ensure that all bedrooms meet the requirements.
It’s also worth considering that an HMO is likely to come with higher start-up and operating costs, such as furniture costs, adhering to fire and environmental health regulations, utilities, maintenance, and letting agent fees.
Finding and funding the right property
The supply of property suitable for being used as an HMO is limited and investors often need to convert existing properties, often using short-term funding to carry out the renovations before refinancing onto a longer-term solution.
Here’s an example of one such case that we were able to lend on at Castle Trust Bank:
The clients were two married investors, a British national and a foreign national, with properties in the UK, Japan, and Malaysia. They were looking to purchase a three-bed terraced house valued at £300,000 and convert it into a six-bed HMO.
The clients intended to use their own funds for the HMO conversion, as well as completing a loft conversion, a refit, and refurbishment – all of which fell under permitted development.
The planned works would significantly increase the value of the property and so the clients were looking for a short-term loan where they only need to contribute 20% towards the purchase, freeing up funds to complete the works, before moving on to a term loan when the refurbishments were completed.
Using our Bridge to Let loan, we provided an 80% gross day-one bridging loan of £240,000 at 0.67% PCM on an interest roll-up basis. The client had 9 months of interest roll-up available, without any payments, to allow for any overruns and also time for letting or sale of the property.
The works were completed quickly and after 3 months, the client opted to switch without an ERC to TermTen, our 10-year Buy to Let loan, which was fixed at 5.29% for the first 5 years. The gross TermTen loan of £318,000 was for 75% LTV of the uplifted value of £425,000. This enabled the client to replenish the cash they spent on the refurbishment, facilitating their next purchase.
Providing guidance
You can provide guidance to your clients around some of the considerations in investing in an HMO, but ultimately, and like any other property investment, the decision whether to invest in an HMO will come down to an investor’s own individual appetite for risk and reward, combined with their desire and ability to take on the extra associated work. The good news is that the lender landscape in the market is increasingly competitive, with new product innovations that can take some of the uncertainty out of an investment in an HMO. For example, as with the case study in this article, a Bridge to Let mortgage can combine a short-term loan that can be used to convert the property so it is fit for purpose, with a guaranteed exit route onto a term mortgage at a lower rate, and a product like this can take some of the stress and complication out of diversifying in a new area that has the potential to deliver greater returns.
