The HMO financial model: How HMOs create high returns, and the costs you need to know

Property Forum’s HMO series covers everything you need to know about sourcing, renovating, financing and managing a successful HMO (House of Multiple Occupancy) property. As well as being jam-packed with helpful links, facts, and guidance, our articles also contain professional tips from Property Forum’s CEO Nicholas Wallwork, as he draws on his 20+ years as a multi-millionaire HMO investor and developer.

This article looks at the HMO model from a financial perspective and includes key costs you should take into account if you are considering an HMO investment.

Understanding the HMO financial model

Let’s take a three-bedroom house as an example. If the house was in a busy town it could earn £1,000 a month in rental income as a standard single let, (being rented to one couple or family). That’s all well and good – enough to cover the mortgage and create a nest egg for the future. But what if investors want a regular income from property, (not just enough to cover the costs of owning the property now), followed by capital growth when they sell up in future? That’s where HMOs can offer significantly more attractive returns.

As well as a large kitchen/diner, our imaginary three-bedroom house features a separate lounge and separate dining room. Now, you could turn the dining room into an additional bedroom, giving you four rentable bedrooms in total (and still leaving a communal lounge where tenants can hang out). In a location popular with young professionals, and with high-quality accommodation, each of these bedrooms could easily be rented out for £525 a month (including bills), earning you £2,100 a month in total – considerably more than renting out the property as a single unit.

Naturally, because the property is being used more intensively, the costs will also be higher, plus there’s a higher chance of void periods (where one or more of the rooms might be vacant). You’ll therefore need to work out your finances carefully before deciding whether an HMO is right for you.

Pro tip: As a general rule of thumb, HMOs costs typically add up to 10–15% of the annual gross income. (More if you pay a managing agent to run your property and manage tenants for you.) However, even taking into account the higher costs, HMOs are still financially more attractive than a straightforward buy-to-let model.

Typical HMO costs

Now we understand the HMO financial model, we need to delve into the typical HMO costs you will need to consider.

• Monthly mortgage payments are the first on the list, and these will vary depending on the lender, the level of borrowing and the type of finance you have.

• You can, of course, manage your HMO completely by yourself, but bear in mind that having an experienced HMO letting agent on your team can be a godsend to help reduce stress and time (especially due to the higher number of tenants you have in an HMO). Management companies typically charge 10-15% of the total monthly rent collected (be aware you may be subject to VAT on top, depending on which company you go with).

• Landlord insurance is essential. Make sure the details of your insurance are correct, that your broker knows your property is an HMO and the security of the property (individual locks on bedrooms doors etc), and that you have the appropriate licence in place. The insurance market place is competitive and vast, so make sure you compare your options.

• Because HMO tenants pay rent to include all utility bills, you will need to factor these costs in. Again, it’s best to compare companies and shop around for the best rate. Make sure you include council tax, electricity, gas and water.

• Broadband and TV packages are typically around £30/ month but don’t forget the TV licence fee on top. TV licensing can be a slightly tricky subject. In theory, every room of an HMO should have its own licence if they have their own TV. In practice, some landlords provide one licence for a TV in the communal living space, and request that tenants need their own TV licence if they want an additional TV in their own room.

• Having regular cleaners might seem a bit unnecessary but you would be surprised how quickly the standard of a property can deteriorate (with 4 or 5 tenants) if the cleaning isn’t kept on top of. Having a fortnightly clean will not only ensure your property is being looked after, but will help avoid any arguments with tenants over cleaning rotas.

• Putting a set amount of money aside each month will help build a reserve for void periods and maintenance costs when they occur. It’s sensible to allocate 5% for voids and 5% for maintenance (from the gross rent). This will provide a comfortable buffer for any quiet periods or unforeseen property issues.

Other articles in our HMO series explain the regulations and licensing rules you need to follow as an HMO landlord. Use the catagory search menu at the top right of the page to see all other HMO articles in this series. You can also download our free HMO ebook (written by our CEO Nicholas Wallwork) and ask any questions in the HMO forum.

Leave a Reply

XHTML: You can use these tags: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <s> <strike> <strong>