Breaking Down HMOs: Everything You Need to Know

The world of HMOs (Houses in Multiple Occupation) can initially seem daunting, especially for new investors. However, understanding the basics of HMOs, their benefits, and the regulations surrounding them can open up exciting opportunities. This guide will cover essential details you need to make informed decisions about HMO investments, including the latest insights on valuation and challenges in the market.

What is an HMO?

An HMO refers to a property rented out to three or more tenants from separate households who typically share common areas, such as kitchens or bathrooms. This setup allows landlords to let rooms individually, often resulting in higher rental income compared to traditional single-let properties. HMOs are common in student housing and areas with high demand for affordable living, such as major cities or towns with transient working populations.

The Housing Act 2004 defines an HMO in multiple categories, including properties converted into bedsits, self-contained flats, or entire houses where tenants share amenities. Additionally, properties converted without complying with the Building Regulations 1991 (Section 257) may also fall under HMO regulations.

Benefits of Investing in HMOs

HMOs offer several benefits for property investors:

1. Increased Rental Yield: Renting out individual rooms often generates a higher return than single-let properties. For example, a traditional family-let property might yield £500 monthly, while converting it into an HMO can yield up to £2,000 monthly by renting each room separately.
2. Diversified Income Streams: With multiple tenants, the risk of vacancy is spread across different units. Even if one tenant leaves, the property continues to generate income.
3. Capital Growth in Restricted Areas: Properties in Article 4 areas, where new HMOs cannot be created without planning permission, can experience increased value due to scarcity. Existing HMOs in these areas enjoy "grandfather rights," which can boost rental yields and capital appreciation.

Key Regulations and Licensing Requirements

Investing in HMOs involves meeting regulatory obligations to ensure the safety and suitability of the property.

• Licensing: Properties rented to five or more tenants require an HMO license in England and Wales. Some councils also mandate licenses for smaller HMOs, so it’s essential to consult the local authority. License costs range from £900 to £1,200 depending on the area.
• Article 4 Directions: Areas with Article 4 restrictions require planning permission for HMO conversions, affecting potential investments. In Article 4 areas, HMO properties are typically valued with a focus on investment potential due to limited availability.
• Room Size: Minimum room sizes apply, with each bedroom needing at least 6.52 square metres to meet HMO standards. Fire safety regulations, including fire doors and smoke alarms, are also mandatory.

Challenges in Valuing HMOs

Valuing HMOs can be complex, given limited transactional evidence and the variety of approaches:

1. Balancing Valuation Approaches: Both bricks-and-mortar and investment valuations are used, especially for highly adapted HMOs. For smaller, less adapted HMOs, vacant possession values often apply. In larger, purpose-built HMOs, however, investment yields become crucial to determining value.
2. Article 4 Impact: In Article 4 areas, HMOs typically cannot revert to single-family homes without planning permission, making the investment approach more relevant. In contrast, HMOs outside Article 4 areas may still be valued based on local vacant possession markets, with yields considered as secondary factors.
3. Lack of Evidence: Good quality HMO evidence is sparse, especially for larger properties, as many investors prefer to retain rather than sell HMOs. As a result, valuers rely heavily on local, recent data or vacant possession evidence to inform decisions.

Financing Options for HMO Properties

Financing an HMO property is often more complex than a standard buy-to-let mortgage.

1. HMO Mortgages: Most lenders require at least a year of experience in buy-to-let before approving an HMO mortgage. However, given HMO-specific risks, some lenders may insist on either a bricks-and-mortar or an investment approach.
2. Bridging Loans: Short-term bridging loans can fund initial HMO purchases and refurbishments, often for investors without a buy-to-let history. Given the higher interest rates, an exit strategy is essential when using bridging finance.

Key Considerations

It is vital to ensure key areas are covered when thinking of a HMO investment:

• Planning and Licensing Compliance: You should verify whether a property is located in an Article 4 area, check its planning permissions, and understand local licensing requirements. Additionally, for properties with seven or more rooms, brokers should confirm Sui Generis planning permissions are in place.
• Market Knowledge: You should familiarize yourself with local market trends and be prepared to explain methodology to valuers. This understanding is particularly important in the HMO sector, where investment expectations may clash with market values.
• Costs and Build Considerations: Red flags include build costs under £200 per foot for ground-up developments and £150 per foot for refurbishments. You should be aware of realistic costs to guide expectations accurately.

Managing an HMO Effectively

Effective management is crucial to a successful HMO investment.

• Property Management: Many HMO landlords hire professional managers familiar with the tenant base and regulatory requirements, ensuring both compliance and tenant satisfaction.
• Tenant Screening: Careful selection of tenants is essential for minimizing issues. For example, professional lets, students, or DSS tenants may each require unique management approaches.
• Regular Maintenance: Higher tenant turnover and increased wear-and-tear mean more frequent maintenance for HMOs. Regular fire safety checks, in particular, are critical for tenant safety and regulatory compliance.

Potential Risks and Challenges of HMOs

While HMOs offer higher returns, they come with distinct challenges:

• Regulatory Changes: Compliance with changing HMO regulations can be costly and time-consuming, with significant penalties for non-compliance.
• Higher Maintenance Costs: More tenants lead to increased wear and tear, which can drive up repair costs.
• Voids and Turnover: Compared to single-lets, HMOs experience higher tenant turnover, which can lead to vacancies and income gaps.

Tips for Maximizing Returns on HMO Investments

1. Target High-Demand Areas: Selecting areas near universities, hospitals, or city centres ensures strong tenant demand.
2. Enhanced Amenities: Additional amenities, such as en-suite rooms or high-speed internet, can command higher rents and attract long-term tenants.
3. Energy Efficiency: With rising energy costs, energy-efficient systems appeal to tenants looking for affordable bills and boost a property’s desirability.

Conclusion: Is an HMO Right for You?

HMOs can be highly lucrative but demand a deep understanding of regulatory requirements, valuation approaches, and effective property management. For those willing to manage these complexities, HMOs offer excellent income potential and capital growth opportunities, particularly in high-demand or restricted areas. However, for newer investors or those without substantial capital, beginning with a standard buy-to-let property may be advisable before progressing to HMOs.