HMO Finance

What to know about investing in an HMO property

Investing in an HMO property might seem like an attractive option, yielding a higher rental income than standard buy-to-let. Despite a slight dip in average HMO rental yields, they are by far the most profitable type of buy-to-let and they are becoming increasingly popular with investors.

Profits can reach up to three times as high as single lets, and the average yield in 2018 was 8.6%, compared with 5.6% for vanilla buy-to-lets, according to the latest index. And as the population increases, the demand for more affordable accommodation is at an all-time high.

But the added income comes with more responsibility, and hefty penalties for getting it wrong. We take a look at what being an HMO landlord entails, and how to go about getting a mortgage for this type of property.

What exactly is an HMO?

The recent regulatory changes for buy-to-let property investors have been challenging for landlords, perhaps even more so for those with multiple occupants. When the definition of ‘large HMO’ changed, more landlords were faced with taking out mandatory licences.

A house in multiple occupation (HMO) is a house rented to three or more people from more than one household, who share basic amenities. A household is a couple, either married living together, or relatives living together. Two friends sharing together would be considered two households.

The property is an HMO if both of the following apply:

  • at least three tenants live there, forming more than one household
  • toilet, bathroom and kitchen facilities are shared.

New rules for licences

 Previously, properties with three or more storeys were defined as large, and landlords had to possess an HMO licence if they had a three-storey property, or larger. But when the legislation changed in October 2018, the definition of ‘large HMO’ changed to any property with five or more tenants.

However, some local authorities require landlords with fewer than five tenants to have licences, so it’s important to check with the council issuing the licence. This is what’s known as selective licensing.

Applications for HMO licences can be made through this government website:

The cost of the licence is set by the local authority and varies, depending on factors such as house size and number of rooms. There’s no set rate: for example, in London, you could be charged £2,500 for a licence in Lewisham, or £120 in the City of London. Most licences throughout the country are somewhere in between.

It can take many months for the application to be processed by the local authority, and the council will scrutinise the both the property and the landlord for suitability. The landlord will need a licence for each HMO property they rent out, and there are discounts given to multiple HMO properties within the same council.

The licence must be renewed every five years, and there are legal conditions attached to licences, outlined here:

  • An HMO landlord must be considered a fit and proper person, with no unspent convictions, verdicts of unlawful discrimination or breaches of housing law
  • Landlords must provide the council with annual gas safety certificates
  • Electrical appliances and furniture must be in a safe condition – the landlord may be asked for safety certificates for furniture and appliances
  • Smoke alarms are installed and kept in proper working order
  • Tenants must be given a written statement of the tenancy agreement
  • Bedrooms must be of a minimum size
  • Landlords must cooperate with the council’s demands on waste disposal

If a landlord is found to be in breach of any of these conditions, they risk a fine of up to £20,000.

Other things to consider:

  • Desirability of location: Houses in urban areas, or those near universities or hospitals, for example, are more likely to be filled than properties in out-of-the-way areas. It’s important to conduct proper research into the area. Is there demand? What are competitors charging?
  • Condition of property: The market is competitive, and if you are renting to young professionals with high standards, the property will need to be maintained to the highest standards, including the gardens, outbuildings and boundaries, which are all the landlord’s responsibility.
  • Council tax: This is payable by the landlord in an HMO.
  • Tenant disputes: The landlord may be contacted due to a disagreement within the property, and the role may extend to one of mediator. If one tenant is unhappy and wants to leave early, it’s worthwhile being open to negotiation, rather than penalising the tenant.
  • Fire safety: More tenants means an increased risk of fire, so fire safety must be paramount. There must be adequate escape routes and a fire extinguisher might need to be provided with larger properties.
  • Comings and goings: There could be a high turnover of tenants, who will need to be checked and referenced, each deposit collected and returned, which can make keeping up with cash flow confusing. Many landlords will opt to use an estate agent or a property management company, as self-managing an HMO can be extremely time consuming.

Finding a mortgage provider

 The majority of lenders prefer to grant loans to seasoned landlords who have owned an investment property for at least one year. While it’s not impossible to find a mortgage for someone with no experience of being a landlord, rates tend to be higher than average on loans and lenders will usually ask for larger deposits.

If the investor owns no other properties in the UK, they will be classed as a first-time buyer for mortgage purposes. In this case, there are fewer lenders that will agree to an HMO mortgage and the criteria will be stricter, and rates will be higher. This isn’t to say that a profit still can’t be made on such an investment.

Smaller HMOs that do not require a licence are often called multi-lets by lenders, rather than non-licensed as the latter can imply that the landlord has not got a licence, even though they don’t need one. Because there is no licence needed, they are valued as single properties. Many of the same lenders that provide finance for licensed HMOs will also provide finance for multi-lets.

Information needed for HMO mortgages

The mortgage process is pretty comprehensive and lenders will ask for more information than for standard mortgage assessments. Some or all of these things may be requested:

  • Landlord experience
  • Personal or limited company mortgage
  • Location of the HMO
  • Whether or not it needs a licence
  • Credit report
  • Loan amount
  • Type of rate preferred
  • Number of AST agreements in property
  • Number of rooms to be let
  • Proposed/actual rental income
  • HMO licence
  • Client profile: as the licence process can take a long time, lenders will make it a condition of the mortgage that the landlord is deemed fit and proper to manage an HMO
  • Types of tenants, (students, professionals, housing association). While lenders are not meant to discriminate, some lenders perceive people in receipt of benefits, or students as high risk.

 Property valuation

 Lenders have their own sets of criteria for HMOs, including how the property is valued. The rental income generated from a house with multiple tenants is generally higher than a single dwelling, and this can work in the buyer’s favour, as the lender will look at the investment value of the property when making a decision. Some lenders, on the other hand, will make the valuation based on similar properties in the area.

But, if the property is the only HMO in the area, it will be valued as if it were a single household which will seriously reduce the loan amount.

Some lenders will restrict the size of the property to five bedrooms, and investors will have to go to a specialised lender for bigger houses, or a high-street bank, which will value the property on commercial, rather than buy-to-let terms.

Availability and rates

Until recently, these mortgages were only provided by specialists, but in February 2019 a major high street bank added an HMO mortgage product to its portfolio, proving that demand is on the increase. Around half of all buy-to-let lenders will provide financing for HMOs. There are currently 11 providers of HMO-specific mortgages.

Rates start at similar levels to other buy-to-lets, but are typically higher due to the number of different factors such as the client’s letting experience, credit history, the property itself and the number of tenants.

Rates are also affected by the loan-to-value (LTV) ratio. The LTV is the percentage of the property owned outright in relation to the amount borrowed. If a £100,000 property is bought with a deposit of £40,000, then the LTV is 60%. Low LTV rates at 60% or less tend to offer the best rates. But it’s best to look at all the costs involved, as ones with lower rates might have higher fees, or vice versa. Lenders will offer either variable or fixed rates.

Other costs to consider with HMO mortgages are broker fees, valuation fees, assessment fees, telegraphic transfer (TT) fees, any early repayment charges and solicitor fees.

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