(Is There Trouble With) Houses in Multiple Occupation (HMO), Anyone?

I’ve had a busy week answering lots of questions from landlords and one asked me about multi-lets. He was worried about HMO regulations and the like, something that you may have heard of.

“Should I be worried?”

“Do I need a license?”

“How much does it cost?”

“If I don’t get a license will I get caught?”

Well for starters what is an HMO? With houses in multiple occupation imagery of derelict bedsits come to mind don’t they? Nothing is further from the truth in London. A lovely 5 bedroom Victorian residence can be considered an HMO as can a bedsit squalor.

The following is defined as an HMO by the national HMO network:

• An entire house or flat which is let to 3 or more tenants who form 2 or more households and who share a kitchen, bathroom or toilet.
• A house which has been converted entirely into bedsits or other non-self-contained accommodation and which is let to 3 or more tenants who form two or more households and who share kitchen, bathroom or toilet facilities. 
• A converted house which contains one or more flats which are not wholly self-contained (ie the flat does not contain within it a kitchen, bathroom and toilet) and which is occupied by 3 or more tenants who form two or more households. 
• A building which is converted entirely into self-contained flats if the conversion did not meet the standards of the 1991 Building Regulations and more than one-third of the flats are let on short-term tenancies. 
• In order to be an HMO the property must be used as the tenants’ only or main residence and it should be used solely or mainly to house tenants. Properties let to students and migrant workers will be treated as their only or main residence and the same will apply to properties which are used as domestic refuges.

There’s a few terms thrown in there like “household” which is defined to death also but in layman’s terms – anyone eating or doing washing together or family-related.

Therefore three friends sharing together are considered three households. If a couple are sharing with a third person that would consist of two households. If a family rents a property that is a single household. If that family had an au-pair to look after their children that person would be included in their household.

BUT…

An HMO is not necessarily a LICENSABLE HMO. When asked about HMOs this is generally what people refer to, as quite frankly, if it has no effect on anything else then why bother calling it an HMO??

What properties need a license? Simple: You need an HMO licence if you own or manage an HMO that is:

• three or more storeys AND
• let to five or more people AND
• made up of two or more households.

So if it doesn’t satisfy all 3 above, then you don’t need a license. In essence what one will find is that letting a large property as an HMO brings all sorts of problems. A lot of investors do it this way, but personally I’m not a fan… reasons below:

• Tenants moving in and out all of the time
• You will need to readvertise rooms regularly (tenants might not get on etc)
• Carry out inspections at every changeover
• Deal with deposit return and other admin every time someone moves in and out
• Tend to repairs more regularly as people treat the property less well (short term views)
• HMO regulations insist on modifications such as fire alarms, fire doors (shame to get rid of beautiful period doors for instance)
• Tempted by high returns but left high and dry with voids due to difficult tenants
• Once a property is registered as an HMO it wouldn’t likely be considered to be a family home for potential purchasers (stigma) hence limiting capital growth
• Finance may be more difficult to obtain as the investment is seen as higher risk – a higher deposit would mean tying up more capital than with other investments.

So in answer to my dear landlord above, costs are substantial. These vary per council of course but Lambeth will want up to £250 PER ROOM PER YEAR upon initial application (discounts available for “Accredited landlords”) which go down a little bit upon renewal, but eat into income of course. As well will your costs of sorting out fire alarms and ripping out your lovely period features. However proceed without a license and you will leave yourself open to prosecution. They have clever ways of picking this up, not just limited to checking how many people are on the council tax bill…

My professional opinion would be to limit the number of tenants to 4, perhaps taking a slight hit on the rental achieved in order to get the capital gain, but in all honesty the better yielding properties (and better for capital growth) have thus far been smaller units.

So bigger units? Great for diversification of course as there is usually a steady demand for family homes, and increasingly so as more and more properties are being chopped in to flats. Perhaps a good long termer, but in the short-medium term look at smaller units. Just look at the yield for now and build cash flow. This way with relatively small deposits one can build a portfolio which you can then diversify with acquisition of (larger) period properties. The problem with older stock is that it appreciates, but the yield is generally less good. This means that you will have to pay a higher deposit because the banks will require that the rent is 125% of the interest payment (always calculated at 5%, to allow for rate rises). Let’s compare two purchases:

A Victorian £400k 1bed flat will rent at 1500ish in a good part of SW2 or SW4.

• That’s £18k per annum rent
• Divide by 1.25 means your max interest payment is £14400 per annum
• Divide by 5% and the max loan you can get on this property is £288k, which means a 112k deposit.
• Realistically you will get a rate around 2.5% so will yield you £900gross per month yield

Ex-local 3bed for £300k in Streatham/Brixton Hill will let at the same money (worst case)

• £18k per annum
• Divide by 1.25 means your max interest payment is £14400 per annum
• Divide by 5% and the max loan you can get on this property is £288k, but capped to 80%LTV, so loan of £240k
• The difference between the mortgage and the rent here is 700pcm at 2.5% BUT you’ve only tied up 60k.

So you can buy two of these for the price of a Victorian. So your 120k will make you £1400pcm gross, not £900pcm. Plus of course the capital appreciation in the long run. HMO or smaller units, I know what I’d do if I was starting a portfolio or adding to a small one.

As always give me a call on 020 3397 2099 for a chat or drop me a line: jeroen@xandermatthew.com – always on hand to answer any property related questions.