Today, homes are being let as HMO properties more often than we’ve ever seen before. A House in Multiple Occupation (HMO) can yield a greater rental income than a traditional buy-to-let property. Rental demand is high all over the UK and, while interest rates remain low, landlords are always looking for ways to maximise the rental yield of their properties. One of the key decisions to achieve this is having the right mortgage.

There has been a marked increase in landlords applying for HMO mortgages, but is it really necessary to do this or will a traditional buy-to-let mortgage be enough?

What is an HMO?

As noted, HMO is an acronym for House in Multiple Occupation. This means that a house is lived in by multiple tenants each paying rent for their share of the property. Another term for this type of arrangement is ‘multi-let’. As a landlord, an HMO allows you to rent your property to multiple tenants rather than renting the entire property to a single tenant.

This enables you to charge rent on a per-room, per-flat or per-section of the property basis. The result of this is usually a greater rental income. It’s not uncommon for HMO landlords to pay the property’s utility bills, unless the property has been converted into flats with separate title deeds on the land registry.

Will I need an HMO licence?

Though the rental yields in an HMO property tend to be higher, the process of setting them up is more complex. In some cases, landlords may be required to get an HMO licence.

Local councils issue HMO licences, which are valid for a period of 5 years if approved. HMO licences are provided for individual properties rather than landlords. This means that if a landlord has 3 HMO properties that require an HMO licence, they will need to acquire a separate licence for each of the properties.

That said, not every HMO requires a licence. It all depends on the size and nature of the setup. Furthermore, different local authorities will have different terms and conditions for HMO licensing. Generally speaking, larger setups usually require a licence while smaller properties are often exempt.

A large HMO property in the UK is defined as the following – all 3 points must apply:

  1. The HMO is rented to 5+ people forming more than 1 household.
  2. The property in question is at least 3 storeys high.
  3. The tenants share facilities like bathrooms, toilets and kitchens.

If an HMO does not meet all 3 of those criteria, there is still a possibility that you will need an HMO licence. Some smaller HMOs are still subject to licensing – it really does depend on the relevant local authority. The fees associated with licensing also depend on the council in question, as well as the length of time it takes to process your application.

What if my HMO licence is declined?

HMO licences are not always approved. Your application can be declined. Councils will evaluate a number of conditions, including whether the property in question is suitable to be an HMO to accommodate the proposed number of tenants. Councils will also assess the landlord that submits the application to ensure they haven’t breached any landlord laws in the past.

If your application for an HMO licence is turned down, you have the right to appeal to the Residential Property Tribunal. In some cases, the rejection may be conditional, indicating that certain elements of the property must be improved to a certain standard to get approved for a licence. Once you get your HMO up to that standard, the council may reconsider their decision.

If your HMO requires a licence, you must not attempt to rent the property as an HMO without acquiring one. This is a very serious offence that can result in an unlimited fine. In some instances, where landlords have failed to comply with housing standards, there can even be a prison sentence.

HMO vs traditional buy-to-let

A traditional buy-to-let property is generally set up to accommodate a single person or family as the sole tenant. In terms of rental, a single rent payment would be due from the household, either on a weekly or monthly basis. The household also pays its own utility bills. These arrangements are sometimes referred to as ‘single-lets’.

Let’s examine why an HMO is often considered more profitable than a traditional buy-to-let:

Traditional buy-to-let

4-bedroom semi-detached house with 2 reception rooms

Rented to a single family, consisting of 2 adults and 2 children

Monthly rental income = £900

Annual rental income = £10,800

HMO buy-to-let

4-bedroom semi-detached house with 2 reception rooms

1 reception room converted to an additional bedroom

Rented to 5 different working professionals or students

Monthly rental income per tenant = £400

Total monthly rental income = £2,000

Total annual rental income = £24,000

From the above example, it’s clear how HMO properties are more profitable, which is why more landlords are considering them. The difference in gross rental income is actually enormous.

How is an HMO property valued?

Valuing an HMO is a specialised process and professional help from an experienced surveyor is advised. Certain HMOs can be valued on a commercial basis – this means a calculation based on  the rental income and the yield, resulting in a higher value than if only the bricks and mortar were assessed. Whether your HMO is valued on a commercial basis or as bricks and mortar depends on your circumstances.

There is a myth that the value of an HMO is the rent multiplied by 10. Many also think that lenders decide the value. Misinformation like this can be very confusing, so we’ll try to delve into the process of valuing an HMO property in more detail.

The first thing to note is that 75% of lenders will only lend against bricks and mortar if the HMO is a small one (6 beds or less). The other 25% will have some restrictions on the amount they are willing to lend on a newly-converted HMO. In some cases, a property’s value will turn up as roughly 10x the rent, but it can be significantly lower or higher. Commercial loans are usually calculated against the rent.

The problem of valuing against rent is that it is more complicated than just multiplying the rent by 10. If you buy a 4-bed house for £175,000 and convert it to a 6-bed HMO where each room goes for £400 per month, the annual rent will be £28,800. Multiply that by 10 and the value of the property would be £288,000. But a comparable property on the same street is available for the original price you paid for the property – £175,000 – so why would a buyer pay your price when they could convert another into an HMO for over £100,000 less?

With a new HMO that qualifies for a lender that offers commercial valuations, there are often restrictions that last up to 2 years after the conversion. These are aimed at minimising the LTV and ensuring you leave money in the property. In some cases, the restrictions will permit no more than 60% LTV. As the new HMO is not tested on the market, its success has not been determined, so lenders reduce the loan to minimise their risk. However, not all lenders are quite so strict – we can achieve 75% LTV for clients with a proven HMO track record, but this is not guaranteed.

When deciding how to commercial value a property, a surveyor will consider the area where your proposed HMO is located. If the surrounding properties are mainly only-occupier homes, HMOs may not be in-demand so your HMO would be more likely to be valued as bricks and mortar only. A surveyor will also pay close attention to the compliance of your HMO – if it doesn’t meet the minimum space requirements or fails to meet legislation in any other ways, the value of the property will be affected. Lenders will instruct their valuer to base the valuation on a ‘vacant possession’ value (VP). This is bricks and mortar and market value – based on a local yield that incorporates an element of multiplying rent in the final valuation.

The valuer will assess the gross rent and make reductions for things like repairs, refurbishments and management. Next, they capitalise the net rent to reach a capital value figure before comparing with other similar residential properties and HMOs in the local area. If the lender accepts this type of commercial valuation, the valuer will look at HMOs in one of four ways:

The property can be used for multi-let purposes with minimal works to convert. The property could also be used as a single let.

In this instance, buyers are likely to purchase a comparable property and convert it themselves rather than pay a premium for the property in question. This means the property will be valued on bricks and mortar alone. Some lenders will base the loan on a single let rent while others will base their calculations on the total rent by room.

There is no Article 4 or planning permission in place. The building has undergone significant change to be converted to an HMO and cannot be used for single let purposes.

With no Article 4 and no planning, with other units in the area being sold as private dwellings, the valuation will assess whether there is demand for an HMO in the area. If there is, and there are comparable HMOs to go by, the lender may be willing to work off the commercial value.

Article 4 is in place.

For a property with 6 beds or fewer, Article 4 presents a barrier to new HMOs. The valuer will consider comparable properties and rents to provide a valuation on commercial value.

Planning permission granted to use the property as a large HMO

For a property of more than 6 bedrooms, with Sui Generis (class of its own) planning permission in place, the valuer will consider comparable properties in the locality and base their calculations on commercial value.

HMO income and expense

Not every HMO will generate more than 2x the rental income of a standard buy-to-let. You need to factor in that landlords usually cover utility bills in these arrangements. That said, even if the annual utility bill is £2k-£3k in the above example, the rental profit is still considerably higher.

The running costs for an HMO are usually higher and require more of your time and effort. For instance, you will need to provide locks for each room so that your tenants’ belongings are secure. The health and safety guidelines for HMOs also tend to be more comprehensive than for a standard buy-to-let. Consequently, the setup costs for an HMO tend to be higher than for a regular buy-to-let.

You also need to consider void periods. The traditional buy-to-let model may have fewer void periods, whereas there tend to be more in an HMO. There may also be higher maintenance bills for landlords in an HMO due to the shared communal areas like kitchens, bathrooms and lounges.

Shared areas tend to ‘get left’ since tenants don’t want to clear up after other people. It could end up being down to landlords to ensure communal areas are clean, either by doing the work themselves or hiring cleaners to keep standards high.

HMOs are often provided furnished. This is another cost for landlords to factor in. It is common for traditional buy-to-let properties to be rented unfurnished. HMOs are popular among single tenants as they offer affordability and the simplicity of renting a fully furnished room with all bills included in the rent. Students, contractors and overseas employees on visas are particularly keen on this type of arrangement. The practicality of moving in quickly at minimal cost is appealing in these circumstances.

HMO location

HMOs tend to do best in certain locations. This is because they often target certain types of tenants, such as students or single professionals. To attract these types of tenants, the location of an HMO generally needs to be in central city locations that have good access to local train/bus routes and amenities. An HMO located in a rural property would be unlikely to attract tenants.

Traditional rental properties are far less limited when it comes to location. Letting agents have been able to rent properties in virtually any location imaginable – rural, country, city; it really doesn’t matter.

Tenant criteria

HMOs can be more complex and challenging to manage compared to traditional buy-to-let arrangements. With facilities in an HMO usually being shared, tenants can sometimes clash and have arguments. This means that, in addition to being a landlord, you may find yourself having to act as a mediator between tenants who are having a dispute.

A traditional buy-to-let model typically encapsulates a family or at least people who have made the choice to live together. Thus, disagreements are usually resolved by the household without the landlord having to be involved.

For this reason, landlords tend to set up an HMO as either a student household or an HMO for working professionals – never a mix of the two. Mixing students with working professionals is a recipe for disaster.

HMO mortgage criteria

The majority of HMO mortgage lenders will need landlords to demonstrate experience in letting property. The pool of lenders who will consider new landlords with zero experience is very small and, for those that will, the rates offered will probably be higher than average. Some lenders also have a preference for who manages the HMO – they may prefer a letting agency to take control than for you to do it yourself.

Despite the popularity of HMO setups, HMO mortgages are considered a niche mortgage type. The application process is more complex and comprehensive than for a standard buy-to-let mortgage. In most cases, you will need to apply through a qualified mortgage broker like Think Plutus, as HMO mortgages are not usually offered direct to landlords.

Lenders are likely to require information on some or all of the following:

  • Experience as a landlord
  • Whether the mortgage is personal or through a limited company
  • The location of the proposed HMO
  • The number of lettable rooms
  • How the property will be managed (landlord or letting agency)
  • Does the HMO require a licence?
  • Does each room have its own AST agreement?
  • Rental income
  • Types of tenant (professionals, students, housing association)

These requirements will be in addition to all the standard mortgage assessments. These include affordability, the amount you need to borrow and a look at your credit history.

HMO mortgage lenders

It is crucial to get the right HMO mortgage for your property. If you take an HMO mortgage with unnecessarily high rates and fees then you won’t be making the most of the rental yields. If you intend to rent a property as an HMO, then an HMO mortgage is what you need. If you already have a traditional buy-to-let mortgage but want to make the switch to an HMO model, consult your lender first to find out if they will grant permission.

Different HMO mortgage lenders have different criteria so the best way to secure the right deal is to go through a whole of market mortgage broker. The nature of your HMO will rule out some lenders from your options and a broker can advise on this. Some lenders put a cap on the number of rooms they are willing to lend on so it’s important to know if you meet a lender’s criteria before you apply. An HMO mortgage adviser can offer guidance on this. Another factor that can make a difference is whether or not the HMO requires a licence.

Lenders for licensed HMOs

Most HMO lenders will consider an application on anything up to 6 bedrooms. If your plans are bigger than this, you may need to seek commercial finance. If your HMO requires a licence, you are more likely to need an HMO mortgage as a standard buy-to-let won’t be enough.

The type of tenants you plan to rent to can also have an impact on which lenders are available. Some lenders will not consider your application if you plan to rent to students or housing association tenants. This is because those tenants are seen as higher-risk.

There can be benefits to having a licensed HMO – it can improve the way a lender values the property. Lenders are likely to consider the proposed rental income when they assess a property’s value. If you have converted a property and plan to withdraw some equity, this can be a significant advantage. Not all lenders value HMO properties on the basis of rental income – many will base their valuation on the property’s value as a standard home. This can limit the amount they offer to lend, defeating the purpose of seeking an HMO mortgage.

Lenders for non-licensed HMOs

If your HMO does not require a licence, many lenders will assess it as being too small for an HMO mortgage. I this case, they may only consider you for a standard buy-to-let mortgage. There may be some lenders who would still consider an HMO mortgage application, but we cannot give you a specific answer without understanding the nature of your HMO. You can contact Think Plutus any time and get some guidance from our expert advisers.

HMO mortgage rates

The rates associated with HMO mortgages tend to be higher than with standard buy-to-let products. This is because there is less competition in the HMO mortgage market. Lenders that offer HMO mortgages will charge slightly higher rates and fees for the privilege of acquiring this niche mortgage type. Having said that, the income from an HMO should be plenty to cover the mortgage, utility bills and maintenance with profit left over. What’s more, an HMO mortgage usually takes the proposed rental income into consideration, meaning the maximum mortgage amount you can access much higher.

HMO mortgages can be provided on variable and tracker rates. LTV rates typically start at 80% LTV, and you will usually get more attractive rates if you can offer a higher deposit.

HMO mortgage broker & buy to let specialists

To make the most of a HMO you will need to crunch the numbers. The advisers at Think Plutus specialise in HMO mortgages and can help you achieve maximum rental income by making an assessment of your plans. The first step to maximising your HMO profitability is to secure a great mortgage deal. The majority of mortgage deals with preferential rates are offered exclusively via mortgage brokers.

It is not recommended to approach a lender directly hoping to secure a HMO mortgage. You will not have the same comprehensive understanding of that lender’s criteria as a whole of market HMO mortgage broker. A mortgage broker can ensure you approach the right lender with a strong application in order to access the best possible rates. You can contact Think Plutus at any time to get the process started and we’ll help you on your way to making your HMO plans a reality.

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