Blue banner with "Are HMO's a good investment?" in front of a 3 storey brick residential terrace

Categories: buy to let mortgages | hmo | guides

An HMO is a property where three or more unrelated individuals live, sharing communal amenities like bathrooms and kitchens. Many investors are curious about the potential they hold and may be considering an HMO mortgage to invest in one. This guide looks at HMO investments, aiming to answer the question: "Are HMOs a good investment?”

Contents

What is an HMO investment?

An HMO, or House in Multiple Occupation, is a property rented out to three or more individuals who are not from a single 'household' (i.e., not a family). They share facilities like the bathroom and kitchen. Typically, these are university students or professionals living in urban areas looking for an affordable home.

There are two main types of HMOs:

  1. Standard HMO: This is the most common type where a property is rented by at least three unrelated tenants. They share facilities like the kitchen and living spaces and may share bathrooms.
  2. Large HMO: a 'large HMO' is defined differently lender-by-lender, but typically houses five or more tenants and, as above, share some facilities.

To understand the difference between standard rental properties and HMOs, consider this: a standard rental property is generally let out to a single person, couple, or family. All tenants form one single 'household'. In an HMO, the property is divided among multiple 'households'. This can increase the rental yield. However, it may also require more intensive management.

HMOs represent a unique niche in the property market. They offer a solution for affordable housing. Especially in areas with high rental demand. However, with these potential benefits come a different set of responsibilities. This can cause challenges for the landlord or investor.

Pros of HMO investment

Potential higher returns

One of the most appealing aspects of HMOs for investors is the potential for higher financial returns. Due to the nature of the property, wherein multiple tenants pay rent, the total income is often greater than that of a traditional single-let property.

For instance, if you were to rent out a three-bedroom house to a family, you'd receive one rent. However, if the same property is converted to an HMO and you rent out each room, you could receive three separate rents. When combined, this can be significantly higher than a single rent payment.

Diversification of income risk

Investing in HMOs can also offer a buffer against the financial risks of vacancies. In a traditional rental property, if your tenant leaves, the property becomes entirely void of rental income until a new tenant is found.

By contrast, with an HMO, even if one tenant leaves, there are still other tenants in the property generating rental income. This can ensure a steadier flow of income, making cash flow more predictable and stable.

Demand in student and urban areas

HMOs are incredibly popular in urban centres and university towns. Students often look for affordable digs close to their place of study. This makes HMOs a good option.

Similarly, young professionals moving to cities for work often want an affordable, conveniently located home. This consistent demand can make HMOs a good investment in such areas.

Long-term tenancies

The “community” feel, combined with affordability, can lead tenants to stay for longer. Longer tenancies reduce turnover costs. This means more predictable rental income, and decreases the hassle and expense of finding new tenants frequently.

Opportunity for value addition

HMOs offer the chance to add significant value. A regular home can be converted into an HMO to tap into the higher rental yields they offer. Improvements in amenities, safety standards, and living conditions can also justify higher rents. They may also increase the overall value of the property.

Cons of HMO investment

Higher management intensity

HMOs inherently house more individuals. This can lead to more management tasks. Communal living can result in disputes among tenants. Shared facilities, noise levels, or cleanliness can all be potential problems.

Also, the wear and tear on common areas tend to be higher, given the increased usage. This leads to more frequent maintenance. For landlords, this means spending more time addressing issues and ensuring the smooth operation of the property. Albeit as a landlord you can use a letting agent to manage this for you – but this will come with a cost.

Licensing and regulation

Operating an HMO is not as straightforward as a traditional rental property. The regulations governing HMOs are stringent.

Depending on the size and location of the property, landlords might need to obtain a specific HMO license from the council local to the property. HMO licences are valid for up to 5 years so assuming the property remains an HMO, this licence will require renewal, which comes with a cost.

Ensuring that the property meets health and safety standards, fire regulations, and other criteria is a big task. Regular checks are par for the course, and non-compliance can lead to large fines.

Initial setup cost

Converting a standard property into an HMO isn't always simple. It might mean structural changes to maximise space or meet specific HMO regulations.

You may need to add fire doors, create more bathrooms or ensure proper sound insulation. These can all carry a considerable cost. They can make the initial outlay for an HMO higher than other property investments.

Mortgage and insurance

Not all lenders offer HMO mortgages. Those that do may have more specific criteria and higher interest rates than for a standard buy to let property. It doesn't end with securing the mortgage.

Insurance premiums for HMO’s may be higher than for standard properties, due to perceived increased risks.

Potential for void periods

While HMOs can offer higher returns, they aren't without risks. They must be maintained to a good standard and cater to the needs of the target demographic. If not, it might remain vacant for extended periods. This is especially true in areas with lots of competition. A vacant HMO not only loses rental income but also still incurs costs. Utilities, council tax, and maintenance all need paying for regardless of voids, which can reduce profit.

Best area for HMO investment

Key factors to consider

Choosing the right location for your HMO investment can significantly impact its success. Some of the critical factors to bear in mind include:

  • Proximity to universities and educational institutions: HMOs are particularly popular among students. Being close to a university can ensure a steady stream of potential tenants.
  • City centres and transportation hubs: Living close to city centres or major transport links is appealing to many people.
  • Employment zones: Being near major employment areas or business hubs can attract working professionals. Especially those who like shorter commutes.
  • Local housing and rental demand: Supply and demand is crucial. A high demand with limited supply is always best.
  • Regulatory environment: Different areas may have varying HMO regulations. Being aware of local licensing requirements, potential zoning laws, and other pertinent regulations is essential.

How to research and identify potential areas

Making a well-informed decision requires research:

  • Local market research: This involves understanding average rental yields in the area. Studying local property listings and get a grasp on occupancy rates. Platforms like Rightmove and Zoopla can provide valuable insights.
  • Networking: Build relationships with local estate agents and property managers. Attend local property investor meetings. This can often uncover insights not available through broad market research.

Conclusion

HMO investments certainly come with a unique set of advantages, from the potential for higher returns to the diversification of income risk. However, they're not without challenges – the heightened management intensity, regulatory requirements, and complexities around mortgages and insurance can be daunting for some.

For those considering delving into the world of HMO investments, it's vital to conduct thorough due diligence. Weighing the pros and cons in light of one's own financial situation and investment goals is essential. An HMO might be an excellent addition to one investor's portfolio while not suitable for another. The key lies in understanding the local market, aligning the investment with one's broader strategy, and being prepared for the unique challenges HMOs present.

FAQs

Buying an HMO can be a good investment. Particularly in areas with high demand for shared accommodation. University towns or urban centres may be best. Potentially higher rental yields due to multiple rent-paying tenants can offer attractive returns.

However, HMOs also come with more management responsibilities and regulatory requirements. As with any investment, it's essential to conduct thorough research. Assess whether it aligns with your investment goals and risk tolerance.

The return on investment (ROI) for HMOs can be higher than traditional rental properties. This is because of the multiple streams of rental income from the individual tenants. It's hard to pinpoint a specific average ROI.

ROI varies based on upfront property investment costs, location, property condition, and management efficiency. HMOs in areas of high demand can achieve significantly higher returns than standard lettings. Always conduct local market research to gauge potential ROI.

The average yield on an HMO can range anywhere from 6% to 15%. However, this is a general estimate. Actual yields can vary depending on the area and how the HMO property is managed. Properties in prime locations with high tenant demand can command higher yields. HMOs near universities or city centres may be best. But, although yield might be higher, the associated costs and responsibilities can be greater.

Some pitfalls include higher management intensity, with potential tenant disputes and increased wear and tear. There is also more regulation with licensing requirements and regular safety checks. There is also the potential for large fines for non-compliance.

Also, the initial setup costs for converting a property into an HMO and meeting regulations can be large. Securing mortgages and insurance for HMOs can be more complex and may be more expensive than for traditional rental properties.

Starting with HMO investments involves a few critical steps. Firstly, conduct market research to identify potential areas with high HMO demand. Networking with local estate agents and attending property investment seminars can provide valuable insights.

Secondly, understand the local regulatory environment, including licensing and safety requirements.

Finally, assess your financial capability, considering initial setup costs, potential mortgage complexities, and ongoing management expenses.

In an HMO, tenants typically share facilities like kitchens and bathrooms. A multi-let property, such as a block of flats, will usually provide each tenant with their own separate facilities.

Converting a property into an HMO is possible but requires careful consideration of several factors. Firstly, the property layout should be conducive to housing multiple tenants. Secondly, local regulatory requirements, such as safety standards and potential licensing, need to be met. Lastly, consider the financial implications. These include conversion costs and potential changes in insurance premiums and mortgage-related costs.