HMO Property Investment Guide: Tips to Reduce Costs and Maximise Returns
HMOs (known as Houses in Multiple Occupation) have gained significant popularity among property investors in recent years, and for good reason. Their attractive returns are hard to ignore, especially as the demand for affordable housing continues to rise.
There is currently a lot of pressure on the housing market to supply cheap and flexible living for different tenant types and 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.
But is investing in HMOs as simple as many make it out to be?
In this guide, we take a deep dive into this more advanced property investment strategy and see if it is really a viable option for the average buy-to-let landlord and investor.
Contents
- Introduction to HMOs
- Do HMOs offer the best returns and profits?
- How to buy a HMO
- Adding value with a renovation
- Financial aspects of HMO investments
- A quick house of multiple cccupation comparison calculation
- Optimise your HMO layout
- Legal and regulatory considerations
- Managing a house of multiple occupation
- HMO landlord tips
- A case study - How not to do It
- Investing in HMOs - Conclusion
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by Robert Jones, Founder of Property Investments UK
With two decades in UK property, Rob has been investing in buy-to-let since 2005, and uses property data to develop tools for property market analysis.
1. Introduction to HMOs
What is a HMO rental property?
A HMO stands for a House in Multiple Occupation. This is a property rented out to at least three tenants who aren't from the same household but share facilities like bathrooms and kitchens. This definition covers a wide range of properties, from traditional house shares to purpose-built student accommodations. The most common property type is often converted Victorian and Edwardian terrace houses. Large houses that were once 3-4 bedrooms that have since been converted or extended to make 5,6 and sometimes even 7 bedroom houses of multiple occupation.
Houses of multiple occupation can work for many tenant profiles from social housing, students and professional tenants.
Why is the HMO Business Model so Popular?
HMOs have become increasingly popular in the UK property market for several reasons:
- Affordability for Tenants: In many city and towns, especially those with high housing costs, HMOs offer a more affordable option for individuals who can't afford to rent an entire property on their own.
- Higher Yields for Landlords: The potential for higher rental income makes HMOs an attractive investment option. By renting out individual rooms rather than the whole property, landlords can often achieve higher overall returns.
- Increasing Demand: The growing number of students, young professionals, and single-person households has led to increased demand for flexible, affordable housing options.
- Housing Shortages: In many UK cities, there's a shortage of affordable housing. HMOs help address this issue by making more efficient use of existing housing stock without the need to build on green belt land outside of areas where housing demand is critically needed.
- Changing Lifestyle Preferences: Many young people prefer the social aspects and flexibility of shared living arrangements, particularly in the early stages of their careers.
The HMO market has evolved significantly in recent years. While traditionally associated with student housing or lower-quality accommodation, there's now a growing trend towards high-end, professionally managed HMOs catering to young professionals and key workers.
2. Do HMOs Offer The Best Returns and Profits?
HMOs vs Traditional Buy-to-Let
While both HMOs and traditional buy-to-let properties can be profitable investments, they differ in several key aspects:
- Rental Income: HMOs typically generate higher gross rental income. For example, a 3-bedroom house rented to a family might yield £1,500 per month, while the same property converted to an HMO with 5 individual tenants might yield £2,500 per month, you can see how the rental income can grow significantly from the same property asset.
- Occupancy Risk: HMOs can offer some protection against void periods. If one tenant moves out, you still have rental income from the others, unlike a traditional let where a vacant property means no income at all.
- Management Intensity: HMOs generally require more hands-on management. With more tenants, there's a higher likelihood of maintenance issues, conflicts between tenants and even neighbours, and more frequent tenant turnover.
- Initial Investment: Converting a property to an HMO often requires a significant initial investment for modifications like additional bathrooms, fire safety measures, and furnishings.
- Regulatory Requirements: HMOs are subject to more regulations, including licensing requirements and specific safety standards.
Potential Returns and Yields
HMOs can offer significantly higher yields and profits than traditional buy-to-lets. While a standard rental might yield 4-8% gross, well-managed HMOs can achieve 10-15% or even higher in some areas.
For example:
- Traditional Buy-to-Let: A £250,000 property rented for £1,500 per month would yield 7.2% gross (£18,000 annual rent / £250,000 property value).
- House of Multiple Occupation: The same £250,000 property converted to a 5-bed HMO, with each room rented for £500 per month, would yield 12% gross (£30,000 annual rent / £250,000 property value).
However, it's crucial to remember that gross yield doesn't tell the whole story. HMOs typically have higher running costs, so the net yield (after expenses) may not be as dramatically different from traditional buy-to-lets unless you have at least 4-5 bedrooms to maximise the total rental income from the asset.
3. How To Buy A HMO
Sourcing a hmo investment can be done in a couple of ways depending on how much time and money you wish to invest. There are a range of opportunities including:
Conversion
This involves purchasing a standard residential property and converting it into an HMO. This approach can offer good returns but requires careful planning and often significant upfront investment.
Pros:
- Potential to add significant value to the property
- Ability to design the HMO to your specifications
- Can be cheaper than buying a ready-made HMO
Cons:
- Time-consuming and potentially stressful
- Risk of unexpected costs during conversion
- May require planning permission which can get denied or licensing requirements which can be costly to develop the property to those standards
Ready-made
Buying an existing HMO can be a quicker way to start generating income, but it's crucial to perform thorough due diligence.
Pros:
- Immediate income generation
- Less initial work required
- Existing licensing and compliance in place
Cons:
- Often more expensive to purchase
- May inherit problems or outdated designs
- Less opportunity to add value
Purpose-built
Investing in newly constructed, purpose-built HMO accommodation is becoming increasingly popular, especially in university towns.
Pros:
- Modern, efficient designs
- Often come with guaranteed yields for initial periods
- Typically fully managed, reducing landlord involvement
Cons:
- Usually require larger initial investment
- Less control over property management
- Potential for oversupply in some areas
When choosing your approach, consider your budget, time availability, DIY skills, and local market conditions. For example, in areas with Article 4 directions (which restrict HMO conversions), buying a ready-made HMO might be the only viable option.
4. Adding Value with a HMO Renovation
Extensions
The first way to increase your chances of HMO property success is to look at extending into the garden or yard at the back of the property. This, of course, can either be a one or two-story extension.
This type of development can be a very cost effective way to add additional rooms (bedrooms, bathrooms and living rooms) to your property, and is especially worth while in high value areas, where the cost of the extension can also add significant value to the price of the property making the HMO worth more than neighbouring properties.
Garage conversion
If the property has a connected garage and off road parking, this can be a great use of space. If the garage already has significant space it can be a good renovation to convert this space in to a large communal area as the location is often on the party wall to the kitchen, so knocking through and extending the communal space can be a great win.
This can be the most cost effective type of conversions for adding additional floor space to your property and you can easily check any local planning requirements with the government planning portal and local council.
Interior Design
When it comes to increasing the return and profits on your HMO, interior design is very simple to do, it can be very cost-effective and it works to set your property apart from local competition. This can increase your rents per week and improve your occupancy rates with tenants staying longer.
Something that you will find - when you start, researching HMOs in a given area - is that the rooms on offer tend to be very standard and really quite boring. Some HMOs on the market may look quite tired and run down or at best the bedrooms might look a little basic.
Don't be afraid to stand out and remember your staging photographs (those used in promotions) are very important to attract the highest quality tenants. If you spend a little bit of time and resources early on with a professional interior designer, this can provide a significant return on investment.
5. Financial Aspects of HMO Investments
House of Multiple Occupation Rental Yields
HMOs typically offer higher gross yields than standard buy-to-lets, often ranging from 10% to 15% or more. However, it's crucial to factor in higher running costs and management expenses when calculating net yields.
For example a very rough guide:
Gross Yield Calculation:
- Property Value: £250,000
- Annual Rental Income (5 rooms at £500 per month): £30,000
- Gross Yield: (£30,000 / £250,000) x 100 = 12%
Net Yield Calculation:
- Annual Rental Income: £30,000
- Annual Expenses (maintenance, management, insurance, etc.): £12,100
- Net Income: £17,900
- Net Yield: (£17,900 / £250,000) x 100 = 7.2%
While the net yield is lower than the gross yield, it's still likely to be higher than a comparable traditional buy-to-let property.
Note this calculation is a guide, without any finance costs like a mortgage included. Below we look a bit deeper, to see the potential the return on investment.
HMO Running Costs
Understanding the full cost implications of a HMO investment is crucial for accurate financial planning. Here's a breakdown of typical costs:
Initial Setup Costs:
- Property purchase (including stamp duty, home survey and legal fees)
- Renovation and conversion costs (if applicable)
- Furniture and appliances
- HMO licence fee
- Safety certificates (gas, electrical, fire)
Ongoing Running Costs:
- Mortgage payments
- Insurance (building, contents, and specialist HMO insurance)
- Utility bills (often these are included by landlords)
- Council tax
- Regular maintenance and repairs
- Cleaning of communal areas
- Management fees (make sure to use a specialist HMO management company)
- Advertising for new tenants
- Accountancy and tax return costs
It's important to budget for these costs when calculating potential returns. Many novice HMO investors underestimate ongoing costs, leading to cash flow issues.
Return On Investment (ROI) Calculation Example
Let's consider a more detailed example of a 5-bedroom HMO in an english university town:
Initial Purchase:
- Property Purchase: £250,000
Includes:
- Cash invested 50% loan to value: £125,000
- Mortgage 50% loan to value: £125,000
Initial Investment
- Cash invested 50% loan to value: £125,000
- Stamp Duty: £10,000
- Legal Fees: £2,000
- Renovation and Conversion: £30,000
- Furniture and Appliances: £15,000
- Initial Certificates and Licensing: £3,000
Total Cash Invested: £185,000
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Annual Income:
- Rental Income (5 rooms at £500 per month): £30,000
Annual Expenses:
- Mortgage Interest (50% LTV at 5%): £6,250
- Insurance: £1,000
- Utilities: £3,000
- Council Tax: £1,500
- Maintenance and Repairs: £3,000
- Management Fees (12% of rental income): £3,600
Total Annual Expenses: £18,350
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Net Annual Income: £30,000 - £18,350 = £11,650
ROI Calculation: (£11,650 / £185,000) x 100 = 6.29%
While this ROI might seem low, remember that it doesn't include potential capital appreciation. Also, as the mortgage is paid down over time, the ROI will increase. The ROI will also continue to increase as rents increase over the years of ownership.
6. A Quick House of Multiple Occupation Comparison Calculation
The "5 Month Rule"
A useful rule of thumb in HMO investing is the "5-Month Rule". This suggests that the income from approximately 5 months of the year will cover your annual running costs for an HMO.
Here's how it works:
If your HMO generates £2,500 per month in rent:
- Annual rental income: £2,500 x 12 = £30,000
- Estimated annual costs: £2,500 x 5 = £12,500
This leaves 7 months of rental income as potential profit (before tax and mortgage principal payments).
While this rule isn't exact and can vary depending on your specific circumstances, it provides a quick way to estimate expenses when evaluating potential HMO investments on a quick like for like basis.
7. Optimise Your HMO Layout
Bedroom Size Requirements
UK regulations stipulate minimum bedroom sizes for HMOs:
- Single bedroom: At least 6.51 square meters
- Double bedroom: At least 10.22 square meters
- Rooms for children under 10: At least 4.64 square meters
However, these are absolute minimums, and many local authorities have higher standards. For example, some councils require single rooms to be at least 8 square meters.
For professional HMOs it is very unusual to have children staying in the property, so although it's worth noting that rooms below 4.64 square meters cannot be used as bedrooms at all, regardless of the occupant's age, planning for rooms around 8 square meters minimum can be a good standard.
When planning room sizes, consider that larger rooms can command higher rents and may be more attractive to potential tenants. A common strategy is to create a mix of room sizes to cater to different budgets and preferences, as some tenants will opt for the smaller room in the house to have slightly lower rents, which the opposite is true for tenants seeking more space and willing to pay a premium.
Communal Spaces
Well-designed shared areas are crucial for tenant satisfaction and can help reduce turnover. Consider the following when planning communal spaces:
- Living Areas: Provide comfortable seating and entertainment options. A good rule of thumb is to ensure seating for at least two thirds the number of tenants at any one time.
- Kitchens: Ensure adequate food preparation areas, storage, and appliances. For larger HMOs, consider multiple kitchens or kitchenettes to reduce congestion at peak times.
- Dining Spaces: Provide a dining table and chairs. This could be in the kitchen or a separate dining room, depending on the layout. Expecting tenants to eat in their bedrooms alone or on their lap at the sofa in a communal lounge is not a winning formula for attracting the best tenants.
- Outdoor Spaces: If possible, offer outdoor areas like gardens or patios. These can be a significant selling point, especially in city areas where space is limited. They are also a great communal space and help bring all the tenants together.
- Study Areas: For student HMOs, consider providing quiet study spaces if the property is large enough. This will help you stand out from the competition who often maximise the number of bedrooms but not communal space.
Remember, the quality of communal areas can significantly impact tenant satisfaction and, consequently, occupancy rates and rental income
Kitchen and Bathroom Guidelines
Adequate kitchen and bathroom facilities are crucial for HMO compliance and tenant comfort. Here are some guidelines:
Kitchens:
- Provide one set of cooking facilities per 5 tenants
- Ensure sufficient food storage space, including at least one cupboard per tenant
- Provide adequate refrigerator and freezer space
- Install appropriate ventilation (usually an extractor fan) as relying on tenants to open windows may not be enough
Bathrooms:
- Aim for one bathroom for every 3 tenants
- For HMOs with 5 or more occupants, consider providing a separate toilet in addition to the bathroom(s)
- Ensure all bathrooms have a washbasin, toilet, and bath or shower
- Provide adequate fan extractor ventilation in all bathrooms
En-suite bathrooms can be a premium feature, allowing you to charge higher rents for these rooms. However, they also increase initial conversion costs and can complicate plumbing maintenance.
When planning kitchens and bathrooms, consider future maintenance. For example, using easy-to-clean surfaces and durable fixtures can save time and money in the long run. This preparation can save you thousands of pounds in maintenance costs, throughout your years of ownership of the property.
8. Legal and Regulatory Considerations
Licensing Requirements
Most HMOs in the UK require a licence from the local council. The specific requirements can vary, but generally you should be looking out for mandatory licensing requirements, additional licensing requirements and selective licensing requirements.
Some local authorities have additional licensing schemes that may require licences for smaller HMOs. Always check with your local council for specific requirements in your area.
To obtain a licence, you typically need to:
- Ensure the property meets the required standards
- Submit a detailed application form
- Pay a fee (which can vary significantly between councils)
- Pass a 'fit and proper person' test
Licences usually last for 5 years, after which you'll need to renew.
Operating an HMO without a required licence is a criminal offence and can result in hefty fines or even imprisonment.
Health and Safety Regulations
HMO landlords must ensure their properties meet strict health and safety standards, including:
Fire Safety:
- Install interlinked smoke alarms on every floor and in every key room
- Ensure clear escape routes
- Install fire doors on key rooms ensuring a safe escape route and protected rooms
- Thumbturn locks on doors for safe and easy exit
Gas Safety:
- Annual gas safety checks by a Gas Safe registered engineer
- Provide tenants with a copy of the gas safety certificate
Electrical Safety:
- Electrical Installation Condition Report (EICR) every 5 years
- Regular PAT testing of portable appliances
General Safety:
- Adequate heating and ventilation
- Safe and secure windows and doors
- Prevention of trip hazards
Overcrowding:
- Adhere to minimum room size requirements
- Ensure the property isn't overcrowded based on its facilities
Regular inspections are crucial to ensure ongoing compliance with these regulations.
Planning Permission and Article 4 Directions
In some areas, you may need planning permission to convert a property into an HMO, especially for larger HMOs (7 or more tenants).
Additionally, some local authorities have implemented Article 4 directions, which remove permitted development rights for HMO conversions. This means that even small HMOs (3-6 tenants) may require planning permission in these areas.
Article 4 directions are often implemented in areas with high concentrations of HMOs, typically near universities. They're designed to give local authorities more control over the spread of HMOs and maintain a balance in the local housing market.
Before investing, always check:
- Whether the property already has HMO use class (C4 or sui generis)
- If there are any Article 4 directions in place
- Local planning policies regarding HMOs
Failing to obtain necessary planning permission can result in enforcement action, including having to return the property to its original use.
9. Managing A House Of Multiple Occupation
Self-Management vs Professional Management
Deciding whether to self-manage or use a professional management service is a crucial decision for HMO landlords. Here's a detailed comparison:
Self-Management:
Pros:
- Lower costs, potentially increasing your net yield
- Direct control over property and tenants
- Ability to build relationships with tenants
- Potentially faster response to issues
Cons:
- Time-consuming, especially with higher tenant turnover
- Requires extensive knowledge of regulations
- Can be stressful, particularly when dealing with conflicts
- May be challenging if you don't live near the property
Professional Management:
Pros:
- Saves time and reduces stress
- Expertise in regulations and best practices
- Efficient handling of maintenance and tenant issues
- Potentially better tenant screening and retention
- Useful if you're not local to the property
Cons:
- Higher costs (typically 10-15% of rental income)
- Less direct control over day-to-day operations
- Quality of service can vary between agencies
Your choice will depend on your experience and your level of comfort managing the day to day of the property and your tenants requirements. The advantages of having a quality management company is vast and it provides you with a peace of mind that is well worth it in our opinion.
10. HMO Landlord Tips
Reducing Utility Costs
Controlling utility costs is crucial for maintaining profitability in HMOs. The cost of electric and gas is growing each year and managing these costs is a necessity. Consider these approaches:
- Energy Efficiency: Install energy-efficient appliances, LED lighting, and proper insulation to reduce energy consumption.
- Smart Thermostats: Use programmable or smart thermostats to control heating and cooling efficiently.
- Water-Saving Fixtures: Install low-flow showerheads and dual-flush toilets to reduce water usage.
- Utility Caps: Consider implementing a 'fair usage' policy with caps on included utilities.
- Educate Tenants: Provide guidance on energy-saving practices and the environmental benefits of conservation.
- Regular Monitoring: Keep a close eye on utility bills to quickly identify and address any unusual spikes in usage.
Keeping A Happy House Among Tenants
Maintaining a peaceful living environment is key to keeping tenants happy and staying for long periods of time. This isn't just good for the household but also for your stress levels. Some tips include
- Careful Tenant Selection: Screen potential tenants not just for financial stability, but also for compatibility with existing tenants. Ask your current tenants what makes a perfect housemate.
- Clear Communication: Establish clear channels for tenants to communicate with each other and with you or the property manager.
- Conflict Resolution: Have a defined process for addressing and resolving conflicts between tenants don't leave it to chance.
- Regular Check-ins: Conduct periodic check-ins with tenants to address any brewing issues before they escalate.
- Community Building: Organise occasional social events or activities to help tenants build positive relationships.
- Swift Action on Complaints: Address serious complaints quickly and fairly.
11. Case study - Guide On 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.
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.
There are thankfully now smarter solutions for keeping utility costs low.
For instance, smart thermostats are getting quite sophisticated these days. Google's Nest is one, Inspire is another.
12. Investing in HMOs - Conclusion
HMO property investments in the UK and especially in major cities offers exciting opportunities for higher rental yields and portfolio diversification.
However, it also comes with increased responsibilities, regulatory requirements, and management challenges. Success in this sector requires:
- Thorough market research and location selection
- Careful financial planning and budgeting
- Understanding and compliance with legal and regulatory requirements
- Effective property management and tenant relations
- Ongoing education and adaptation to market changes
This guide is to help you plan ahead, to help you learn from both successes and challenges this advanced strategy has to offer
Investors can indeed build a profitable HMO portfolio, but remember to conduct thorough due diligence, stay informed about local and national licensing, planning and housing regulations as they can (and do) change frequently.