The HMO market is encouraging substantial investment as investors recognize just how lucrative this asset class can be.
A House of Multiple Occupancy (HMO) or a “Multi-Let” is a rental property occupied by three or more unrelated people forming one household. Typically, each bedroom will be rented individually with a shared kitchen, bathroom and living areas.
Current size and key segments
Many banks and mortgage brokers indicate that there are a growing number of casual investors in real estate hoping it will become their sole source of income. Others, do not intend to become property investors; rather they have inherited a house or kept a previous home when they traded up to another.
According to the Council Tax: Stock of Properties Notes of the Valuation Office Agency, there were 25M domestic properties with a Council Tax band in England and Wales as of 31 March 2015. This represents a year-on-year increase of under 1% since March 2014. Breaking this statistic down by region:
- England: 23.6M properties
- Wales: 1.4M properties
Taking a look at the largest shares of domestic properties with a Council Tax band in England:
- South East: 3.8M
- London: 3.5M
- North West: 3.2M
Growth and drivers
The driving force behind the growing popularity in HMOs is that they can provide increased rental income, serving either as a primary or secondary source of income. Investors have looked at maximizing the returns on their assets and renting individual rooms can enable investors to multiply the returns they would get versus renting to a single family.
The HMO trend is unlikely to slow in the short-to-medium term. In fact, The Royal Institution of Chartered Surveyors (RICS) 2015 report shows the number of enquiries to rent property comfortably outstrip new supply of rental property from landlords. As a result, RICS expects rents to continue pushing upwards, further increasing investor interest in rental properties.
According to River Source Properties Ltd., a UK property investment management team with an HMO focus, HMOs offer returns far in excess of the market norm for rental properties. They have seen many of their HMO deals grossing yields in excess of 17%.
An interesting change in the markets occurred at the end of last year as returns on so-called “multi-unit freehold blocks” – which involve buying a block of flats or a converting a building into apartments – slightly surpassed that of HMOs (9.3% vs. 9%). Meanwhile, HMO rental yields, while higher than the traditional buy-to-lets, slipped last year in Q4 by 1.4% from the same period a year earlier. (See graph below.)
Nevertheless, experts agree that this year HMOs will produce the best income, and attribute the referenced drop to the fact that these numbers are “gross” and don’t take into account the costs of servicing a mortgage, maintenance costs, ground rent and or add-ons like agent fees and income taxes.
Entering the Market
So where does one begin? First, identify areas where there are large populations of at least 20,000 working-age people. This information is accessible from the Census Bureau as well other sources.
Then look at existing rented accommodations and their availability as well as their attractiveness from an aesthetic/location standpoint. Assess the area’s access to public transportation, parks, good roads, etc. Get to know the local planning authorities and the government’s acceptance of property conversion as some areas may not encourage or even allow for it.
RICS expects all parts of the country to see modest price increases during 2015 with the strongest growth in the North West, South East, West Midlands and Yorkshire. More specifically, areas that advisors recommend currently are:
- Bexley Heath
A good rule of thumb is to seek a minimum return of 10% of the value of an HMO investment, bearing in mind that the investor needs to account for empty periods or additional unforeseen costs. Furthermore, debt should be kept to manageable levels as rising interests rates could be a burden on cash flow.
Licensing is aimed at raising management and amenity standards to ensure that HMOs are properly maintained. Licensing is not mandatory in all cases, but it is a complex process, requiring approval from the local council. In some cases penalties of £20,000 can be incurred for renting out an unlicensed HMO.
Additionally, landlords are required to provide Energy Performance Certificates (EPCs) for their HMO properties.
Compare with normal buy-to-let
A study conducted by Property Wire concluded that 50% of landlords with HMO properties in their portfolios were planning on adding additional HMOs to their portfolios in 2015. This compares with 23% of buy-to-let investors.
Why is this the case? A large number of buy-to-let investors have become accustomed to unnaturally low interest rates for the last few years and they are expecting to suddenly see their margins dramatically narrowed should interest rates go up.
HMO landlords are less concerned, as they have greater margins. This gives ample coverage for any potential rise in interest rates.
The bottom line is that the HMO market is growing. An investment in HMOs can become a profitable addition to an investment portfolio, provided one conducts the proper due diligence prior to the investment and adheres to the fiduciary responsibilities, maintenance and upkeep, that come with it.