The Complete HMO Property Investment Strategy For Buy-to-Let Landlords
With the returns, they deliver it's easy to see why HMOs have become so popular over the last few years. The demand for affordable housing is increasing in most large towns and cities and there is currently a lot of pressure on the housing market to supply cheap and flexible living for different tenant types.
Renting by the room alleviates a lot of the pressure that is currently placed on the UK's housing stock.
The reason for this is twofold.
- It's more affordable for the tenant.
- It increases capacity. Single buildings can be used to provide multiple homes.
HMOs can work for many tenant profiles from social housing, to students, to professional tenants.
And, they are also becoming very popular with landlords. This is because the returns that landlords can achieve with HMOs are excellent.
Often, a landlord can expect double the yield from an HMO than they would from a vanilla buy-to-let.
So the business model for HMOs looks great. Both sides of the equation are catered for. You have a rising demand as well as a rising supply - making for a perfect match!
But is investing in HMOs as simple as many make it out to be?
In Today's Video We Look At:
- The pros and cons of the HMO (houses of multiple occupation) strategy.
- Where you can make your money.
- Is this strategy right for you?
- A few real-life case studies on how buying an HMO and managing multiple tenants actually works.
Houses of Multiple Occupation - The Basics
There are many different strategies for making money from property.
Rental income (yield) is one of them. But, there are many different ways to use and make money from your rental yield as well.
Most buy to let property is rented out to couples, individuals or families as one household. This is the more traditional route to making money as a landlord.
However, there are other options.
Depending on where the property is located, there might be a market for renting out individual bedrooms instead of the property as a whole.
A property that is rented out in this way is called either a multi-let or an HMO (a house in multiple occupancy).
How HMOs Work
If you want to read a complete and legal definition of what exactly constitutes an HMO property in the UK we recommend that you check out gov.uk - Houses in Multiple Occupation and then come back to us.
What's important is that HMOs are a booming market and the demand for individually rented rooms is growing fast.
As you will have no doubt seen in the news the situation today is that many younger tenants are being priced out of the traditional rental market.
This is due in part to increasing demand for larger deposits and in part to living costs which are continuing to rise.
So, as a landlord, one way of responding to this situation is by renting out individual bedrooms to tenants rather than the whole property.
Not only does this provide housing options that are more affordable to your potential tenants but by doing this you can also significantly increase your yields - and therefore your income - as well.
Investing in HMOs is a specialist strategy, not to be taken lightly.
But, it is one that is becoming increasingly popular.
If you are considering this strategy it is very important that you get the right information before you start.
What I want to do here is to make sure you have the information you need so you don't need to make the same (costly) mistakes I made when I was learning about HMO investments.
I also want to make sure that you understand the legal / health safety regulations that go alongside HMO management.
But, in this regard I strongly recommend - if you are serious about this strategy - looking at central government and local council websites where you are going to find a lot of useful information.
I also recommend that you speak to your local authority who will employ housing officers and possibly even a dedicated HMO officer.
These people are well worth contacting about what the local requirements (for HMOs) might be and they will often even help you with your market research in that they may even tell you where in your local area is oversaturated with HMOs and where there may be potential for further development.
Note: Although your local HMO officer can be a great help when it comes to understanding the local housing market you still need to do your own research. Bear in mind that their job is to improve the housing situation for the area and not to make you money!
Rental Demand | The Best HMO Areas
It should come as no surprise that the best HMO areas are in cities or larger towns.
Your first port of call should be spareroom.co.uk - Rental Index.
SpareRoom is a site where a lot of HMO landlords go to list their rooms and where tenants go to find them.
But, as well as the main site itself they provide a free room rental index which will show the demand for room lets across the country.
As part of the site, they provide a free room rental index which shows the demand across the country in different locations for room lets.
This is a great starting point for your research!
From this, you will be able to see what the demand might be in your area. You can also snoop around the site and see just how many properties are listed and how many tenants are listed as seeking properties.
But, your research shouldn't end there.
It's important that you do the groundwork.
You need to know exactly what the demand and supply are for any area in which you are thinking about investing.
How to Select the Best Location for your HMO
Market research is a big topic. For an in-depth, over the shoulder look at how we go about researching an area for potential HMO investment opportunities please watch the video below.
In it, Rob discusses how to select an area for investment based on 5 main criteria which are:
HMO Rental Yields
When compared to more standard buy to lets the rental yield on an HMO should be much higher.
When becoming an HMO landlord for any property you consider you should be looking at a minimum 12% gross yield although 15%+ yield is often easily achievable.
The downside here is that HMOs typically require more management and therefore more of your time.
The truth is that managing even a couple of HMO properties can be a bit of a handful and for a lot of investors can be a bit too much to handle.
After all, a lot of us got into the property business to build a passive income, right?
So, if you don't want to be putting the work in yourself, it will be important to have a management agent who is skilled in looking after HMOs (and tenants), if you want to build a systematic strategy that you can scale later on.
For HMOs, the running costs are usually higher too.
As a general rule of thumb, I have found that it costs around 4-5 months rental income (worst case scenario) to run an HMO.
This may sound like a lot but I am taking everything into account here.
When doing their calculation a lot of investors tend to ignore factors maintenance, arrears, void periods, utility bills, insurance, management and the costs involved with finding tenants.
Breaking the Costs Down
In a 4 or 5 bed multi-let, you will usually find the income from one of the rooms covers the costs of maintenance, utility bills and voids or arrears.
This is a quarter of the house, or, seen another way, it's a quarter of your yearly rental income - equivalent to around 3 months when spread out over the year.
Another months income is then usually enough to cover management costs and insurance.
This is a very general rule of thumb, but one that will help you to look at an HMO quickly and see if the rental return is right for you.
If you don’t include bills your return on paper will look higher. But, if you do this you may not be charging enough per room.
And, if the property is self-managed, you should save yourself a healthy chunk of this money and increase your NET yields.
But, what you save in cash you will spend on time.
So whether you choose managed or self-managed your net yield will be higher than with single lets.
And this choice is personal. It's up to you to decide whether your additional income is going to be worth the extra time and involvement you'll need to spend on your investments.
Your Personal Situation
If You're Cash Rich and Time Poor
If you have ready cash available for investment the most obvious strategy for investing in an HMO is to put together enough for a deposit and get a mortgage to cover the rest.
But, you need to be aware that raising mortgage finance for an HMO can be more difficult that raising mortgage finance for more standard vanilla buy to lets.
Most mortgage lenders take the view that it should only be more experienced landlords that manage these types of property.
They may also require a much larger deposit - 25-35%. Obviously, you will need to check with your mortgage broker or financial advisor to see what is available.
What your Mortgage Broker Might be Looking For
For instance, before financing the property your mortgage broker might want to see evidence of the following.
- Experience in owning properties as a landlord.
- The ability to raise commercial finance - NOT just standard buy to let mortgages - is often considered beneficial.
- Great local management contacts to manage the property.
- Experience in managing different tenant types - IF you are planning to self manage.
The timeframe for purchasing an HMO and getting it running depends on the property you are looking to buy.
If you are looking to convert a property into an HMO some will require licensing. However licensing doesn't just concern the registering of the property.
Some local councils will require that the building adheres to certain criteria in order for it to be used as an HMO.
In some cases, you might even need planning permission to convert a property into an HMO. This can happen when you try to change standard residential accommodation into something else.
Because of these factors, the time frames involved in getting an HMO working for you is usually longer than a straightforward buy-to-let.
So before you purchase a property in order to convert it to a multi-let you need to know what rules and regulations are going to apply.
For more information see:
And, at the bottom of this article, I have provided a few links to all of the necessary legislation requirements you will need to meet as an HMO landlord.
Another option is to buy properties that are already running as HMOs.
Buying houses that are already functioning as HMOs is going to speed up the process.
However, for this luxury, you may end up paying a premium.
With this in mind, I recommend that you consider carefully which of the two options is going to be best for you.
Full Costs | Anatomy of an HMO Deal
Please Note: The following assumptions apply to this calculation:
- That equity and capital growth are similar or the same as a standard buy to let. In other words, we are looking at rental yield ONLY.
- The mortgage is based on a £75k loan and is interest only, at 6%.
- Other letting costs are based on 5 month’s rent per annum. These include maintenance, management fees, voids, arrears, insurance, utility bills - and all other costs.
Return On Investment ROI (Rental Income Per Annum)
|Total Purchase Costs:||£105k|
|(£100k purchase + £5k costs)|
|Gross Rental Yield:||15%|
|▶ Gross Rental Income (per annum):||£15,750|
|Mortgage payments (per annum):||£4,500|
|(on a £75k mortgage @ 6% interest)|
|Other Letting costs (per annum):||£6,562|
|▶ Total Costs:||£11,062|
|▶ Net Rental Inc. (per annum):||£4,688|
|Invested Amount- Deposit + Cost:||£30,000|
|(£25k deposit + £5k costs)|
|▶ Net ROI:||15.62%|
As you can see when compared to the standard buy-to-lets... HMOs offer an ROI on your rental income that can be significantly higher.
An HMO Case study - How NOT To Do It
The very first property I did as an HMO was a REAL learning curve.
It was only a four-bedroom property. For my first HMO, I wanted to start small and I felt like 4 was a good number of tenants to have.
This Was My First mistake...
Since then I’ve learned that it is hard to make a decent profit from a 4 bed HMO.
This is because the rental income that you make is often not enough to cover the extra work and maintenance costs that are required.
Sometimes you find that 4 bedrooms HMOs even need MORE management than a 5 or 6b bed, NOT LESS.
This is because with a 4-bed property every penny counts. You need to keep voids and utility bills extremely low to keep up your margins.
However, the location was great. It was right in the centre of town. It has always rented well... which is why I went for it in the first place.
But, this wasn’t the problem.
What you find with HMOs is that tenants are always more transient. You tend to have a higher tenant turnover than with straightforward buy to lets.
My Second Mistake...
The property was located about 45 minutes drive away from where I lived at the time.
Now, with a traditional let, this wouldn't cause a problem.
But, when you are self-managing an HMO, distances like that can be a real pain. The drive to the property to do regular viewings soon added up and proved to be a real drain on my time.
However, this wasn't the most costly mistake I made. This came with how I was managing the costs of the property.
One thing I have always done with my HMOs and shared property is I have included utility bills in the rent.
There are arguments for and against doing this.
But, what I have found is that doing this helps to get rooms in my properties rented faster.
Tenants want things simple after all. They don't want to split utility bills every month with other tenants whom they might not otherwise speak to.
An all-inclusive offer is definitely a selling point in this market.
The downside to doing this is that your tenants might not take ownership of the situation. That's to say that when they are paying for utilities, as a set amount, in their rent, they might not be paying attention to their energy usage.
When bills are included you might find, as I did, tenants in their rooms, the windows open, the heating on full blast... crazy!
This was my Third Mistake...
I gave my tenants instructions on how to use the boiler. I asked them not to put it on constant. I asked them to turn it off when they were out.
I assumed they would be responsible.
Having given tenants clear instructions on how to use the boiler. I'd told them not to put it on constant and I'd told them to turn it off when they're out.
I assumed they would look after it and be responsible. In the first month of my first HMO.. my gas bill was £250!!
And this was in summer
So, experience has taught me to approach the issue of utility bills differently.
And, the next thing I tried was to use electric heating only with meters in each room. This way the usage was controlled and the tenants had to pay at the source.
It was more costly to implement at the beginning, but over time I really say the benefit.
I know a few landlords who have done exactly this and their bills are around £200 per year (as they just cover communal areas). What a difference...
But, there are other things that can be tried.
Smart thermostats allow you - as an HMO landlord - to control the heating remotely, from your tablet or phone. You can make sure that the property is warm in the winter and cool in the summer.
Of course, you always want your tenants to be comfortable but you don't want energy to go to waste.
Of course, another thing you can do is make sure you are using energy-saving lighting, preferably LED lighting throughout the property.
The more energy-efficient the property is the more money you will save in the long run.
3 Things I Learned From My First HMO
If I could have my time again with my first HMO these are the three key things I would do differently...
- I would keep strict control over the utility bills – if you have broadband, put call barring on outgoing calls on the phone line. If you have gas central heating, box in the boiler and set times for it to control your costs
- I would choose the location carefully – local is always best if your self-managing. If you have a managing agent, going further afield may not be a problem but make sure they are geared up for managing the types of tenants you have. Standard lettings agents aren’t good enough. You need to have someone with experience with HMOs.
- I would have picked at least a 5-bed property. This will improve your returns for not much more effort.
A Real-Life Case Study (When It Goes Right)
HMOs need to be in very specific areas.
But, if you pick the right location converting a house into an HMO can turn a poorly performing property around.
One of our HMOs is a 4 bed, multi-let in Manchester.
The previous landlord had run the property as a student let but the student market in the area had changed.
There had been a shift in where students were choosing to let.
Over time the students had started to migrate to other locations in the city. There had been a lot of development and the universities had started to invest in new, purpose built accommodation closer to campus and nearer the city centre.
The property was suffering. The landlord was struggling to find regular tenants and was experiencing long void periods.
We bought the property and took over.
Our goal was to change the tenant profile that the property was marketed toward. We decided that we weren't going to look to attract students but working professionals.
And, our approach was to be as flexible as possible with the tenant terms. We decided we were going to fairly open with regard to lowering our admin fees, allowing shorted lets and accepting smaller deposits.
Generally speaking, the property was in great condition! It was ready to let and fully furnished.
Some of the rooms were already tenanted when we took over.
With a change of management style we were able to turn it around quickly and it now rents out at around £80pw/per room.
This gives us around £1,386 per month gross rent when fully tenanted whereas a single let in the same area would only generate around £650 per month in rent.
By managing the void periods and by selecting the right long-term tenants - and by keeping on top of utility costs... we made a lot more profit on this property than the previous landlord was able to.
But, more importantly, we managed to get a better return on the property as an HMO than we could possibly have achieved by renting it out as a single let.
In 2016 tax changes have come into play both for stamp duty and mortgage interest relief.
This has changed the outlook for the everyday buy to let investor. It's forced them to look at property strategies which will give them higher returns on investment in order to cover the extra buying and holding costs in this asset class.
HMOs have been a key fall back strategy for a lot of investors moving away from the vanilla buy to let model.
This has been in a bid to overcome these changes.
As such HMOs have come under more scrutiny by the government and local councils as investors try and find ways to effectively further monetise this sector.
You Need To Consider the Following:
For a full breakdown of what's needed for an HMO licence click here.
It's important to note that many local councils are bringing in mandatory licensing forcing landlords to pay for schemes even if previously the property didn't require it.
The cost of a licence can vary. It can be from £500 to as much as £1,500 in some areas. Some have claimed that this is nothing short of a money-making scheme cooked up by the councils.
Many authorities are being challenged.
But, it's important to factor in the cost of needing an HMO Licence into your figures.
This is often overlooked but on some property conversions a property converted from a residential unit to an HMO may fall under a different tax bracket for council tax.
To see if your possible deal might require a different council tax banding as a result of a conversion check here.
This mainly impacts properties with en-suite bathrooms or studios.
When it comes to planning for HMOs, national policy is mainly on your side.
Planning, for smaller HMOs (4-6 beds) is often fairly straightforward.
However, local councils have the power to invoke something called Article 4 and some do.
Manchester is one such council.
Article 4 limits any change from a C3 residential house to a C4 house of multiple occupancy.
To check if article 4 could affect you see the NLA Article 4 Policy.