HMO Finance Explained
Welcome to our article where we will provide an overview of what a HMO is, the different HMO finance options available, an overview of the process, the types of lenders involved and things to consider.
What is an HMO?
An HMO, House in Multiple Occupation, is a property which has multiple, non-related, individuals who are co-living in the property, normally on separate AST (tenancy) agreements.
An HMO will typically have a series of shared facilities such as kitchens and bathrooms, which some or all of the tenants will share.
Landlords do not require a licence to run a HMO with 4 or fewer occupants, however, by the definition that the property is being let to multiple tenants, this will typically require a specialist funding solution from HMO specialist lenders, who specialise in underwriting these types of assets.
A property which is let to 5 or more non-connected tenants is categorised as a “large HMO”. Large HMO landlords are required to be licenced by their local council. These properties are often referred to as Licenced HMO’s.
To apply for a HMO licence a landlord must apply to the local council. The council will carry out a series of checks and due diligence on the property and the landlord, then they will grant the licence, which typically lasts for 5 years.
Tenancy agreements in HMOs
It is possible to structure tenancy agreements in two different ways for HMOs, either as individual tenancy agreements for each tenant, or a single “joint and severally liable” agreement, joint agreements are typically suitable for groups of friends or students who may be living together for a period of time. The benefits of a joint contract is that it requires less administration, and tenants are liable for all rent, bills and maintenance of the property.
Individual contracts are more suited for larger properties and HMO’s for young professionals, or lower cost HMO living arrangements. Each tenant pays their own rent, from which the landlord will typically cover the bills, such as council tax and utility bills. The benefits to the landlord is that they can switch the contract over easily if a tenant moves on. The benefits to the tenant is that their rent covers all of their bills, plus if one tenants misses a payment the rest of the tenants are not liable for the payments.
Why invest in HMO’s?
HMO’s can provide investors with higher yields than are available from traditional buy-to-let properties, however, they do come with some complications, with increased requirements from a licencing perspective as well as the physical management of the asset, with increased numbers of tenants.
Rental income is typically double that received renting the property as a “single let”. However, don’t forget that from the rent, the landlord may need to cover the utility bills and other costs associated with the property, which inevitably will increase their costs.
Reduced voids and income
HMO’s tend to have fewer voids that single let properties, whilst individual tenants may move on, generally the occupancy levels will be 80-90%, this means that compared to a single let property the income levels will typically be higher, as you will rarely have a complete void period.
It is also possible to off-set more of the costs against the income that the property generates, as you will be paying for the utility bills, council tax etc.
Managing HMO Tenants
There are two different methods of managing HMO tenants, which are simply, do it yourself, or pay someone else to do it. It may be sensible to use a letting agent in the first instance, as managing 4+ tenants can be quite a lot of work, particularly initially.
If you elect for an external estate agency/lettings company to manage the property, there are a number of factors that you will need to consider:
- The level of service that the agent will provide.
- Letting, renewing, reviewing and receiving rent.
- Fully managed/Part managed
The more that the letting agent does, the more that they will cost, normally up to around 20% of the revenue that the property generates.
What is HMO Finance?
There are a limited number of lenders that will lend on HMO properties, this is primarily because this is a specialist area of finance and most “high street” lenders will not consider lending against these assets.
There are broadly two different types of HMO finance, one which funds normal properties, HMO’s which do not require sui generis planning, so up to 6 individual rooms within a property. These properties are typically classed as “non-complex” by lenders, as they can potentially be returned into a normal family home quite easily. Therefore, lenders will typically lend up to 85% LTV. Lenders will not normally consider investment valuations for these types of properties, i.e. a valuation which is based upon the rental income, as opposed to a “bricks and mortar” valuation. However, there are some specialist lenders which will consider a “hybrid” valuation, which will potentially consider the income from the property as opposed to the standard value.
At the other end of the spectrum, those HMO’s which require sui generis planning, so effectively are licenced and require planning, are generally considered to be a specialist assets, which can’t easily be returned back into a normal single let property, with fire doors, fire alarms and a number of other features. These assets will typically attract an investment valuation, which will be calculated based upon the income that the property generates.
For both types of properties, there are a number of common items that lenders will require as part of their underwriting process for HMO finance, please find included below a brief list:
- Landlords experience – some lenders will require the landlord to have experience with managing HMO’s, although others will not.
- The purchase price of the property.
- Costs of any works required.
- End value of the property.
- Number of lettable rooms.
- Expected rental income.
- Self-managing the property or using a letting agent.
- Borrowing in personal name or through a limited company.
It is recommended that you work with a specialist HMO broker to secure your finance, as a number of the specialist lenders in this space do not accept applications directly from borrowers, plus will potentially secure you the best possible terms.
Costs of HMO Finance
HMO Finance is typically more expensive than standard Buy-To-Let finance, lenders typically view these types of assets as more risky than standard Buy-To-Let, this is primarily due to the quantity of tenants involved, with the potential for partial voids and unpaid rents.
Accordingly, HMO finance is typically priced at around 1.5-2% above a standard Buy-To-Let mortgage.
Commercial Mortgages Broker specialise in HMO finance, offering HMO Bridging Finance, HMO Development Finance and HMO Mortgages, please get in touch with our team today to discuss your HMO Finance requirements, we will be very pleased to assist.