A house in multiple occupation, otherwise known as an HMO, is a property that contains three or more tenants who are not part of the same household.
Landlords often choose to let HMOs because they can be the most efficient way to run a portfolio of rental properties. They generally involve more work for the landlord, but they offer the ability to collect rent from a greater number of tenants, meaning the rental yield is higher. Some properties and locations are ideal for HMOs, such as large, extendable properties in busy student areas. From the perspective of tenants, HMOs can be preferable because the rent payments are likely to be lower and they offer the opportunity to live with more people.
With increased regulations and financial setbacks hitting landlords in recent years, including Section 24 and the 3% stamp duty surcharge, many have looked to maximise the rental yield of their portfolios. Besides incorporation, the most popular approach has been to convert rental properties into HMOs where possible to increase rental returns.
If you are exploring the option of converting a property into an HMO, there are several things you need to do. You’ll need to comply with landlord legal requirements and ensure the property is deemed habitable for more people.
So where do you begin?
One of the fundamental aspects of letting an HMO is to secure the appropriate licence. Updates to the rules surrounding HMO licensing that came into effect in October 2018 were expected to impact as many as 177,000 rental properties.
In order to let an HMO, it’s very likely that you will need a licence of some kind. If you plan to let to 5+ tenants from multiple households, in which some or all share the same toilet, bathroom or kitchen and at least one tenant is paying rent, it’s likely your property will be classed as a large HMO that requires a licence.
If some of these criteria apply, but not all, you might still need a licence. The best approach is to check with your local authority. HMO licences remain valid for 5 years and each HMO you run will need its own licence.
In addition to obtaining a licence, there are various compliance measures you are required to meet. These include registering a valid gas safety certificate with your local authority each year, installing carbon monoxide detectors and smoke alarms and having safety certificates for all electrical appliances available on request.
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:
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
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 property and HMO..
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 most lenders will only lend against bricks and mortar, especially if the HMO is a small one (6 beds or less). Other lenders 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 can be 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 the value of a HMO, 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. Commercial HMO 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.
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.
Minimum room sizes for HMOs
When the licence changes came into effect, there was also the introduction of guidelines for minimum room sizes. As a landlord, you will need to ensure the following guidelines are adhered to:
- You must notify the local housing authority if any rooms in the HMO have a floor area of less than 4.64 m².
- If a room is to be used as sleeping accommodation by a child aged under 10, the floor area must be no less than 4.64m².
- Any room in the HMO where a person aged 10+ is sleeping must be no less than 6.51m² in size.
- Where a room in the HMO is to be used as sleeping accommodation by 2 people aged 10+, the floor area must be greater than 10.22m².
- Any room in the HMO where the floor area is less than 4.64m² must NOT be used as sleeping accommodation.
These regulations also brought new rules into force regarding overcrowding. You must comply with the following:
- Any room in the HMO that is used as sleeping accommodation only by people aged 10+, it may not be used by more than the maximum number of people stated on the licence.
- For rooms to be used as sleeping accommodation by people aged under 10 only, there must not be more people using it than the maximum number stated on the licence.
- Where a room in the HMO is used as sleeping accommodation by a mix of people under 10 and people aged 10+, you must not exceed the maximum number of people in each age category specified on the licence.
Some local authorities also have other criteria that your HMO must meet in order to be fully compliant, so make sure you are aware of your requirements.
Does your property need converting to work as an HMO?
If your property is not already HMO-ready, it may be necessary to make some adjustments in order to accommodate 3+ tenants from separate households. It is always crucial for the property to be habitable and for it to provide sufficient space for all tenants to live comfortably. In addition to the compliance obligations we’ve already mentioned, the key components of an HMO are space, facilities, layout, furniture and appliances.
If you undertake works to convert your property into a suitable HMO, your local authority will visit it within 5 years. When they attend, they will conduct a Housing Health and Safety Rating System (HHSRS) risk assessment to identify any existing issues with the property. It would be wise to stay abreast of any developments with the HHSRS, as it was reviewed by the government in 2019 and could be changed in the near future.
If the visit uncovers any serious risks like carbon monoxide, asbestos or radiation, you will be required to address the issues immediately.
Room conversions for an HMO
It is likely you will need to convert some rooms to make your HMO work. For example, a spare room may be made into an extra bathroom and a reception room might be suitable for an additional bedroom. It may even be necessary to move or build walls to alter room sizes. All these aspects will require careful planning before any work is started. You are strongly advised to hire a professional, particularly when working on the more significant parts of the conversion. You should also determine whether your proposed renovations will require planning permission.
Converting a garage into extra living space is a popular conversion option for a prospective HMO landlord. This is likely to require planning permission so check with your local authority before actually starting the work. Often, traditional Victorian terraced houses and similar property types are excellent candidates for HMO conversion. This is because they tend to be very spacious with large reception rooms.
For example, a 3-bedroom terraced house might be suitable for conversion into a 5-bedroom HMO by modifying a reception room and the loft into additional bedrooms. Converting reception rooms is very common, but it is not always the best move. Ideally, the existing property will have 2 reception rooms – one will be converted while the other remains as living or dining space. Some renters may find a property with no living room or reception space unappealing, so consider this before you make any decisions.
For many properties, a conversion into an HMO will be expensive and time-consuming. Be sure to budget carefully for the project and don’t expect to immediately recoup your losses.
5 quick tips for renovating a property into an HMO
- Kitchens and bathrooms are a priority – these rooms remain particularly important and can be a dealbreaker for renters if they are not up to scratch. Tenants will have high expectations, so be sure to finish them to a high standard and consider adding extra touches like an electric towel rail.
- Don’t neglect your outdoor space – it is tempting to focus entirely on the interior of the property, but your outdoor space is equally important to attract long-term tenants looking for a home. Things like seating and BBQ space are popular with modern renters.
- Make the most of your space – with 3+ tenants from separate households sharing the same space, you need to ensure there is plenty of it! There are various tricks and tips with interior design than can help give the property a spacious feel.
- Never skimp on important features – understandably, you will want to keep the costs down wherever possible, but it is counter-productive to be cheap on important things like ovens, fridges, beds and sofas. Trying to cut corners here will only end up costing you more in the long-term.
- Ensure you are 100% ready to let – tenants will not want to move into a building site. Make sure you have everything finished before they move in – this will reduce the risk of damage or problems arising early on in the tenancy.
HMO safety obligations
When converting a property to make it suitable for multiple occupants, you will need to be mindful of safety requirements in order to keep your HMO compliant. One of the principle considerations is fire safety. Smoke alarms are an absolute must, and you need to keep them in working order and have the means to provide a declaration of their safe condition for your local authority on request.
Concurrently, as with any rental property, you must ensure proper maintenance of all gas appliances. A gas safety check must be carried out by a Gas Safe engineer every year. All electrical appliances and installations present will need to be safe for use, and the furniture you install must meet the latest fire resistance regulations. You will also need to have an Electrical Installation Condition Report (EICR) and test certificates for all electrical appliances. And fire doors will be required in certain places, so be sure that your tenants are informed that they must not obstruct them or prop them open.
On top of all this, you will need to ensure all exits remain clear of obstructions and advise your tenants to do so too. Fire exits should be adequately marked and tenants will need to be instructed as to what they should do in the event of a fire.
Other safety requirements you may want to be mindful of include:
- Emergency lighting for fire safety
- Locks for every bedroom (ideally use thumb turn locks)
- Pest control treatment records
The list of safety requirements for HMOs is extensive and different local authorities will have different requirements. Check with the council first before starting your conversion to ensure you have the full list of requirements to hand.
Other things to consider when creating an HMO
Fitness for human habitation
The Homes (Fitness for Human Habitation) Act 2018 is another piece of legislation that landlords need to comply with. These regulations dictate that all rented accommodation must be suitable for human habitation throughout the entire tenancy. It gives tenants more power to make their landlord accountable if their property falls below the minimum standard.
To ensure your property is fit for human habitation, there are various potential issues you will want to avoid. These include things like:
- Poor ventilation
- Inadequate water supply
- Faulty drainage
If the property contains any of the 29 hazards described in the HHSRS regulations, it is the courts will deem it unfit for human habitation. Landlords are exempt from so-called ‘acts of God’ and issues that are caused by tenants.
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.
Due to the nature of having multiple tenants in your property, it is likely that more stress will be placed on the property through the tenancy. There will be extra wear to doors, floors and fittings/appliances in the bathrooms and kitchens, so be ready to respond to reasonable repair requests quickly and efficiently.
If you take out a landlord insurance policy, be sure it is suitable for an HMO. Not all landlord insurance policies cover houses in multiple occupancy.
One key difference between an HMO and a standard rental property is that a higher turnover of tenants is likely. It is wise to put aside a minimum of 2 months’ rent each year to cover yourself for potential void periods. You will also need to ensure the appropriate tenancy documentation and referencing processes are in place for new tenants.
Doing your research and budgeting
It’s important to prepare the property fully before you begin letting it. Don’t take shortcuts and always ensure you have money put aside to cover maintenance costs during and after tenancies.
Converting a rental property to an HMO can be a highly effective investment that yields great profit, but the work and upkeep mean you will be busier. Before you take the plunge, research everything fully and take the time to weigh the additional work and expense against the additional profit. A considered approach of research and careful budgeting can help ensure you make the right decisions and get the most out of your property investment.
But-to-let mortgage terms for HMOs
When preparing to rent out an HMO, you’ll need to check the terms of your buy-to-let mortgage. Not all agreements permit the property to be let as an HMO, so check the terms and conditions carefully. If you’re not sure about something, it’s worth checking in with your lender or speaking to a specialist buy-to-let HMO mortgage broker like Think Plutus. Your agreement may permit you to get the ball rolling immediately, or you may need to arrange a different mortgage type to proceed.
Think Plutus can answer your questions and help you get onto the perfect HMO mortgage arrangement to achieve your HMO goals. Simply make an enquiry today to speak to an adviser.