HMOs explained

An HMO is referred to as either houses in multiple occupation or houses of multiple occupancy and they have become extremely popular in recent times. As not only house prices, but also rental charges continue to increase, the ability to share facilities within one property amongst at least three tenants is attractive. There are benefits for the tenants and there are benefits for the landlord.

How do HMOs differ from buy-to-let properties?

When researching HMOs on the Internet you will see them described as an asset class of the buy-to-let property market. In reality there are a number of differences between HMOs and traditional buy-to-let property investments.

An HMO has multiple tenants and tenancy agreements while a buy-to-let property has just one tenancy agreement – the buy-to-let tenancy is typically with an individual, couple or family
Tenants of an HMO are unconnected third-parties unlike couples and families who often rent out buy-to-let homes
HMOs have private and shared facilities for all tenants
The rental yield on HMOs is significantly greater than that available with buy-to-let investments involving just one tenancy agreement
All HMO properties are covered by different health and safety regulations compared to buy-to-let properties
Nationally there is a licensing scheme for HMO landlords (with some exemptions) with selective schemes for buy-to-let landlords

Even though many people deem HMOs as an asset class of the buy-to-let market, they are regulated by a different set of rules and laws. Licensing of HMO properties has improved safety and rid the market of some of the more speculative landlords.

What is an HMO?

As we touched on above, the difference between an HMO and a buy-to-let property is the number of tenancy agreements. There are specific guidelines regarding the HMO definition.

• A property rented to at least three unconnected parties is classed as an HMO
• There are clearly defined shared facilities in an HMO such as toilet, bathroom and kitchen
• Large HMOs are rented to 5 or more individuals from at least two different households
• To be classed as a large HMO the property must also have at least three storeys

While the regulations change from area to area, in general landlords of large HMOs will require an HMO licence. However, those leasing rooms to either three or four individual unconnected parties may still require an HMO licence in some parts of the country – check with your local authority.

What additional responsibilities do you have as a landlord with an HMO?

Due to the size, tenancy structure and number of individuals in an HMO there are additional responsibilities above and beyond that of traditional buy-to-let properties. They tend to relate to general standards of living and safety. Legally, no matter what exceptions are written into a lease, the landlord has a duty to:-

• Arrange annual safety checks for gas and electrical equipment
• Provide cooking and washing facilities which reflect the number of tenants in an HMO
• Undertake a five-year check of the buildings electrics
• Avoid overcrowding – this is one of the reasons why HMO regulations have been tightened
• Provide the appropriate fire safety measures with mains connected smoke alarms throughout the property
• Ensure the property is clean and tidy, avoiding hazards which could result in personal injury claims
• Repair and maintain shared areas, with individual tenants responsible for their specific private quarters
• Provide an up-to-date legionella risk assessment

The vast majority of additional HMO landlord responsibilities revolve around safety. Injuries caused as a consequence of landlord negligence will likely lead to personal injury claims. There may also be additional legal action from local authorities.

Where is a good location for an HMO and who is the ideal tenant group?

A good location for an HMO is simply an area where there is significant demand for private rental property. HMOs tend to do very well in areas where rents are relatively high compared to income with benefits for both tenants and landlords. Some of the prime locations for HMOs include:

• Areas with a strong student/higher education population
• Cities with a prominent financial sector attract HMO tenants and landlords because property prices and traditional buy-to-let rent levels tend to be relatively high
• Locations within commuting distance of large cities and vibrant employment markets tend to work well for HMO landlords
• Many HMO landlords look for “micro” locations which are effectively small communities local to employment and education facilities with a varied nightlife

The ideal tenant group for an HMO landlord is one that has secure long-term cash flow. It is also beneficial if the tenant has plans to stay in the region in the longer term as this saves with additional advertising and lost income due to vacancy.

• Young professionals starting out in a new career are ideal tenants especially those who have moved away from their family to follow work
• Students and those pursuing various forms of higher education tend to have tight budgets so the HMO rental structure is ideal
• Corporate tenants can also prove beneficial with no additional advertising costs as companies switch their employees between locations
• Local authorities will often look towards HMO properties where council housing is in short supply

The key to an ideal HMO tenant is reliable cash flow and, in a perfect world, a long-term tenancy. It is essential to take deposits from new tenants to protect against cash flow issues and property damage.

What are the risks and benefits of an HMO?

As with any investment there are various pros and cons towards investing in an HMO. The benefits include:

• It is possible to achieve higher gross rental yields – often up to 3 times that of a traditional buy-to-let property
• Spreading rental income amongst a number of individuals reduces the impact of vacancies – if a tenant moves out of a traditional buy-to-let, rental income stops
• The impact of individual rental arrears is reduced as income is spread across a number of tenants
• Due to the traditional size of an HMO property there can be greater expenditure to offset against income
• As house prices increase and traditional buy-to-let rents continue to rise, HMO tenancies are proving attractive to more and more people

However, there are some downsides to investing in HMOs which you need to be aware of before starting your journey.

• Legislative changes in the future may increase costs and reduce net income
• Raising mortgage finance for an HMO property is not as simple as a traditional/buy-to-let mortgage
• Not all properties are suitable for an HMO conversion which focuses investor demand on a reduced pool of properties
• Converting into an HMO can on occasion reduce the prospects for long-term capital growth due to the cost of reverting back to the original layout
• Landlords may experience higher letting agent charges for HMO properties compared to traditional buy-to-let clients
• It is likely you will require a significant deposit if you are able to negotiate an HMO mortgage

When looking at the pros and cons of investing in HMO assets, there is no doubt that the benefits do still outweigh the risks. That said; it will come down to location, type of property and ability to rent all rooms on a long-term basis.

How do you calculate the potential income of an HMO?

The potential rental income of an HMO is to a certain degree relative to the rental yield on a traditional buy-to-let property. In essence, not only are you spreading the risk of non-payment between numerous tenants but you are also ensuring that individual rents compare favourably to other rental options.

• Traditional HMO rental yields tend to begin at around 8% – this is just above the average breakeven position leaving surplus income
• The overall income from an HMO investment will depend upon the location, facilities and the number of tenants – work out your costs, investigate local rents and factor in a degree of surplus income
• Costs to consider when calculating potential HMO rental returns include utility bills, council tax, repairs, wear and tear, period of vacancy, HMO licence, legal expenses, maintenance and initial conversion costs
• Compare and contrast your potential HMO investment with similar properties in the region – what rent are they charging, how many tenants do they have and how does the quality of your proposed investment compare
• Approach local estate agents/letting agents and ask for their advice on HMO rental yields – it is vital your rate of rent is competitive but also cash flow positive on a net basis

There are many different factors to take into consideration when calculating the potential income of an HMO. Take your time, ask advice and only invest if the figures stack up. HMO investors depending upon long-term capital gains are likely to be disappointed – secure rents and long term cash flow should be top of the agenda.