Over the last 10-15 years, the UK private rental and HMO (houses in multiple occupation) sectors have grown strongly.

From student accommodation to shared housing, HMOs are an attractive option for investors and landlords, but they don’t come without some compromises.

Mark Cotter, Real Estate Director and Anusha Peries, Real Estate Advisor at Private and Commercial Bank Arbuthnot Latham examines the benefits and drawbacks of investing in HMOs.

In 2018, the Government estimated that there were around 4.7 million people within the private rented sector in England and around 497,000 HMOs in England and Wales.

The main reason is affordability issues arising from house price growth considerably outperforming wage growth. ONS data shows the average house price is now £250,000, so a first-time buyer needs a deposit of around £37,500 (15%) to acquire a suitable mortgage, whilst average salaries are only at £30,800. The deposit required in London is considerably more as the average house price here has reached over £500,000.

For landlords, gross yields are higher than a standard buy-to-let property and, while they demand a level of expertise in terms of managing tenants, the buildings and the plethora of legal obligations, the financial yields – on the whole – add up.

In fact, recent stats show that the gross yield of HMO increased by a whole percentage point (to 9.6%) up to 2019. The gross yield for standard buy-to-let increased by just 0.3% over the same period.

Local authorities are also keen on HMOs because they are a tool through which councils can control HMO density and housing stock in a certain area. Councils can – and almost always do – require property owners to seek permission to convert a single dwelling house into a small HMO.

The Government recognises that there is a chronic housing shortage, with a target of 345,000 new homes needed to be built each year to meet demand.

However, as the Government’s own target has never been achieved (and is unlikely to be), there is an essential need for HMO and PRS housing which both investors and local authorities recognise, given that councils have lost much of their housing portfolios and depend heavily on private landlords.

As a consequence, licensed HMOs are required to comply with tighter regulations to ensure they meet minimum safety and quality standards, thereby improving the quality of rental housing stock.

It would seem that the changing reputation of HMOs for renters, and the potential increased gains for investors mean that it’s a growing sector which looks set to develop further while there remains a shortfall of properties at affordable prices for first-time buyers.

It is – therefore – hardly surprising that HMOs have helped drive the recent growth in the private rented sector in the UK.

The benefits of investing in HMO

• Better yields: HMOs offer up to three times higher rental yields than standard properties, making them a great choice for investors. The property’s location, condition, and interior will all determine the rent that can be charged to each tenant
• Fewer void periods: When Landlords rent out a property to one tenant or family, they will have to consider void periods – where the family moves out and the Landlord has to wait for another tenant to move in. In HMOs, it’s likely that at least some of the tenants will remain, even if another one is vacating, so not all rental income is lost overnight
• Arrears less likely: When you let out a house to multiple tenants, you balance the risk of late payments. If one tenant falls into arrears, the rest will still be contributing
• Tax benefits: As spending on HMOs is a revenue cost, this is tax-deductible
• High demand: Whether a Landlord is letting to students or multiple households, demand for HMOs has never been higher, particularly in cosmopolitan cities. An investor must identify the demand and competition before they invest in a property to maximise returns

The drawbacks of investing in HMO

• Mortgage: It can often be harder to secure a mortgage on an HMO than it is to secure a mortgage on a second home or buy-to-let property. Landlords may need to consider alternative financing options to fund the investment/renovation project
• Red tape: Landlords will need to cut through more red tape and overcome legislation to make their HMO work on a legal and financial basis
• Limited capacity: Many properties cannot be converted into HMOs. Landlords will need to find a large property that offers space for every tenant. In some areas, opportunities for HMOs are limited and properties that are ideal for HMOs command higher prices.

The positives and negatives associated with HMOs for landlords are something that must be considered carefully. The rules set out by the Government and local councils alike result in a relatively complex set of guidelines to work within.

However, if adhered to, landlords will likely have ownership of properties that are better managed and maintained than other privately rented, non-regulated properties which in turn will benefit tenants, who expect a better standard of accommodation nowadays than they did before.