Please note: This is Chapter 2 in the Complete Guide to Property Investment Strategies, focussing on Houses in Multiple Occupation (HMO’s).
The aim of this chapter is to equip you with the knowledge around investing in HMO’s and where it sits on the TKM Triangle so you can assess whether such a strategy is for you. (Hint: cut your investment teeth on a Single Let first, then after 12 months experience consider an HMO if it fits your Property Investment Blueprint).
A HMO is an example of Use Intensification as a yield enhancement strategy.
In essence, you are taking a property and instead of renting it out on a single AST (e.g. a couple or family), you are renting it out by the room to unrelated individuals. This means having an AST per room. The tenants have exclusive use of their room plus use of communal facilities such as kitchens and a lounge.
Rent is usually on an all-inclusive basis, covering utilities and council tax.
The basic investment rationale is that the total rent, minus expenses is higher than that achieved on a single let (but for a corresponding increase in risk and management overheads).
The technical definition of an HMO is (as of 1st October 2018):
A property rented out to at least three people who are not from one household (for example a family) but who share facilities such as a kitchen and bathrooms.
The growth of HMO’s has been astronomical over the last few years. This is because:
- As house prices have risen, investors have chased yield to increase returns.
- Knowledge and awareness of HMO as an investing strategy has increased via courses and forums.
- The growth of Rent-to-Rent as a strategy to create income usually relies on an HMO as a way of creating the added value to the investor.
This means that, in many locations, HMO’s have become over-saturated. The natural reaction to that is to try and enhance the product by providing en-suite’s and high-spec finishes, but this impacts returns.
Aside from assessing demand, you need to be aware of the following, if you decide HMO investing is for you:
- The impact of an Article 4 Direction.
- The types of HMO.
- Licensing considerations.
- HMO amenity requirements.
- Planning considerations.
Many people mix up HMO amenity standards, licensing and planning, so let’s go through them in turn.
Article 4 Direction
From a planning use class perspective, residential property is classed as use C3. An HMO is classed as use C4. You (usually) have permitted development rights, or the automatic right, to change from C3 to C4 use without requiring planning permission.
Due to the increasing presence of houses being converted into HMO’s and hence increased population density in areas which have a large proportion of HMO’s (often at the neighbours dismay), some local authorities have implemented an Article 4 directive over some (or all) locations within their control.
An Article 4 direction removes the permitted development rights to change from use class C3 to C4, blocking the right to buy a property and convert it to an HMO without requiring planning permission.
Your local authority website will tell you if such an Article 4 directive restricting permitted development rights from C3 to C4 is in force.
This doesn’t mean you cannot operate HMO’s in an Article 4 area, but it does mean you will have to seek planning permission which creates a planning risk if you buy a property with that in mind but are subsequently refused planning permission. Differ local authorities will apply different hurdles in your efforts to gain planning permission. For example, they may specify that if there are more than “x” houses within “y” radius of your property operating as HMO’s, then you will be refused planning. This is something you will have to research locally.
There are some advantages to persisting in an Article 4 area, however:
- Competition is restricted, as most will be put off by the need to gain planning permission.
- If you have an HMO in an Article 4 area, there is an argument that this attracts a premium price on re-sale due to the need to gain planning permission for one. Hence the supply of HMO’s is restricted.
Types of HMO
HMO’s generally target one of the following tenant demographics:
- Student HMO. Let to a group of students who are all friends, on a single AST.
- Professional HMO. Let to an unrelated group of working people on individual AST’s. This can cover blue-collar workers through to white-collar workers. Clearly the location and specification will affect which group you target.
- Local Housing Allowance (LHA) HMO. Let to an unrelated group of unemployed people on unrelated AST’s.
The vast majority of investors target groups 1 and 2. Group 3 is not for the faint-hearted as such a demographic can come with other social issues and your running costs are likely to be higher as such people are generally in during the day, leading to higher utility bills, although this can be mitigated via the use of separate electric meters in each room. Your potential rental growth is more limited too, since it will largely be set by the LHA allowance for a room in your local area.
Exactly what facilities you offer in your HMO will depend on:
- Your chosen tenant demographic.
- The local competition and market expectations.
For example, if your competition is offering en-suite rooms and this is the market expectation, then you may be at a disadvantage if you don’t provide them.
As of 1st October 2018, any HMO meeting the criteria of being let to 5 (or more) individuals, forming two (or more) households, sharing basic amenities such as a toilet, bathroom or kitchen, will need a mandatory license. In government parlance, this is referred to as a large HMO.
You will need to apply for a licence from the local authority, which comes at an expense and is usually valid for 5 years. The licence is per property, not per individual.
To be granted a licence, you must, in essence:
- Ensure the HMO is suitable for the number of occupants (this relates to the amenity standards).
- That the licence holder (yourself, or a managing agent on your behalf) is a “fit and proper” person. Whilst a bit of a woolly definition, In reality, this appears to mean having no criminal record and not having been in breach of any landlord laws or codes of practice.
Of course, getting a licence comes with a hefty fee. There is plenty of argument that this is simply a revenue raising exercise (after all, good landlords will comply, bad landlords will just fly under the radar) but it is the law, so that’s the way it is. This has to be factored into your plans.
Note that some local authorities have implemented Additional or Selective Licensing considerations. In some cases (such as Nottingham, where I have investments), this means the introduction of Selective Licensing has included single lets (I have had to get a licence for a 1-bed flat)! So, make sure you check the licensing requirements in the areas you invest in and factor this into your plans. It may be that smaller HMO’s will also need licensing as a result under an Additional Licensing scheme.
HMO Amenity Requirements
An HMO investment has to comply with the local HMO Amenity Standards. There are national standards, but a local authority can choose to impose their own standards over and above this. An example of an amenity standard is room sizes. A bedroom for a single occupant must be at least 6.52 square meters (goodness knows how they came up with the 0.52 element) for a licensed HMO. This can include the space within a built-in wardrobe, but not the space included in an en-suite, if provided.
Clearly, this impacts the type of property you buy and what facilities you might look to provide.
There are further rules relating to kitchen cupboard space per occupant, worktop space per occupant, communal facilities such as a lounge and so on.
Your local authority of where you are looking to invest will usually have this published somewhere on their website. DO NOT buy a property for HMO use without understanding these requirements thoroughly as you could be caught out and fail to get a licence if the property were to need one.
As mentioned above, an HMO is planning class use C4, but this is only for up to 6 residents (unrelated individuals). Note the term residents, not bedrooms as is sometimes falsely assumed (probably because 6 unrelated individuals are going to want a bedroom each, so there is some correlation).
So if you want to let to more than 6 unrelated individuals, then such a property would fall into use class Sui Generis and require planning permission. Sui Generis actually applies to a whole host of land and buildings that do not fall into any other use class, such as theatres, petrol stations and so on.
This adds further risk to this type of large HMO and must be accounted for.
Note that this planning permission is different to the planning permission required in an Article 4 area (which removes the permitted development rights to move from planning use C3 to c4). Sui Generis, in this context, is for C4 use to more than 6 unrelated individuals.
TKM Triangle: HMO
An HMO is step up from a single let:
- Time. It can also take more time to manage HMO’s. Not that many Letting Agents will touch them and you have to remember that a 6-bed HMO is essentially 6 different tenancies to manage with the added complication of in-house tenant issues when two or more housemates don’t get on. HMO mortgages are also more difficult to obtain if you are a first-time landlord.
- Knowledge. The regulations around planning, licensing and amenity standards are more involved than for single lets.
- Money. Typically you will buying larger properties with a view to adding en-suites and conforming to the increased regulations required (for example fire doors and mains-wired smoke alarms). This is going to require a larger capital input.
Given the above, HMOs as a property investment strategy should be attempted once you have at least 6-12 months of real-life Single Let investment experience under your belt.