HMO Finance - Licensed and Unlicensed
Bond Finance has acquired a significant level of expertise in arranging finance for these types of properties as the sector as developed from amateur buy-to-let landlords converting their properties to multi-lets informally, to professionals dealing with the increasing burden of national and local formal regulations.
With increasing regulation has come a change in perception that HMO properties no longer offer sub-standard accommodation and can now be shown to offer a respectable form of property investment. Unfortunately most buy-to-let lenders have not kept up with this increase in respectability and rather than embrace this growing sector, refuse to lend.
Bond Finance is approached by increasing numbers of HMO professional landlords, who can demonstrate compliance with HMO regulations and experience, but who have become frustrated by the lack of available finance from their existing buy-to-let lenders.
Common enquiries are
- now unable to approach existing lenders to apply for funding to buy a new HMO
- now unable to approach existing lenders to release equity from existing HMO portfolio to buy new properties – Bond Finance can arrange interest only finance to release equity based on the rental income rather than just the brick and mortar value of the building
- wish to buy a property that will be converted to an HMO and finance required based on the post-works value of the property, with an HMO licence in place. Cheaper than using a bridge loan to buy the property and then looking for post-works finance
- own bank will offer finance, but on a repayment basis, which also limits loan size. Bond Finance can arrange interest only loans
- current portfolio size now too large for existing lenders.
- student lets allowed, but limited to four students and only a single AST allowed
- struggling to find a lender that will allow LHA tenants
Bond Finance is able to arrange finance in all of these situations and we welcome challenging enquiries.
A client owned an HMO with a bricks and mortar valuation of £300k. His expectation was that the maximum remortgage we could obtain was 75% of £300k = £225k, even though the rental income was £36k pa.
We approached a commercial lender to instruct a commercial valuation, taking into account the works that were done to make the property HMO compliant and the rent. The valuation came back at £380k so we were able to obtain 75% of £380k = 285k. ( effectively 95% of the bricks and mortar valuation). This allowed the client to release cash to assist in the purchase of another property.
An existing client wanted to buy a large house in Reading for £400k. It could be converted to an 8 bed HMO. Fully let it would generate a rental income of £4,800pm. The valuer gave the property a current value of £400k and a commercial valuation once converted and the HMO licence approved of a £540k.
We arranged a loan of 75% of £540k. £300K was initially advanced to enable the purchase and the balance was released following a post-works re-inspection of the property.
Valuation Guidelines for HMO's
HMO1 – Bricks and Mortar
A residential property that is simply being rented on a multiple tenancy basis. Minimal works have been carried out to make it suitable to be occupied as an HMO. Change of use planning was not required. If the property has been extended, then this would add value to the same extent as a property that was being occupied by a single tenant or as a main residence. It should be expected that the property would be given a “bricks and mortar” valuation. Here, the use changes the property from C3 to C4, but there is no uplift in value as a consequence of this
HMO2 – C4
A residential property that is not located in an area subject to an Article 4 Direction and therefore its change of use from C3 to C4 is not subject to planning approval. However substantial changes to the fabric of the building have been made in order create the HMO. If the changes were carried out within Permitted Development, then the property is likely to be given a bricks and mortar valuation plus a slight premium to reflect the higher rents the property can now achieve as an HMO, as long as the valuer is of the opinion that these levels are sustainable. If a planning application was required in order to carry out the works, then the premium may be slightly enhanced. When considering the level of premium, the valuer is likely to have regard to similar unconverted properties in the area and how likely investors would buy a ready-made HMO at a premium over buying a neighbouring property and doing the conversion themselves A pure yield-based valuation would not be expected.
HMO3 – Article 4
A residential property located in an area subject to an Article 4 Direction. This removes the right to change the occupancy of properties from C3 Single dwellings to C4 HMOs under Permitted development. The primary motivation for Councils to invoke Article 4 Directions is to restrict the number of properties being converted from C3 to C4 use. Any C4 properties in this situation can expect to command a considerable premium over their C3 equivalent. The valuer is likely to give a yield-based valuation, although they may test this against similar C3 properties, to see how far the yield-based valuation takes them from the inherent bricks and mortar value of the property.
HMO4 – Sui Genris
A property, which required specified sui generis planning in order for it to be occupied as an HMO for more than 6 people. This property may now only be used as an HMO and therefore a yield-based investment should be expected.
Below is some helpful commentary from Mike Frisby
Mike is an experienced property professional, who, with our help, managed to add 100 more rooms to his portfolio during the course of 2016.
1 - HMO definitions & planning types
I have always invested in HMO's but really started focusing on this strategy with a vengeance at the beginning of 2015, as I really came to understand how to unlock the keys to MULTIPLE HMO's with commercial finance. Having seen the market chop & change so drastically as it has over the last few years, I started to see a huge demand for high end room lets in the Greater Portsmouth area. The demand was & is still significant and professional room rates are at an all time high in Portsmouth. Also, as a lot of you will know a bulk of my portfolio was geared towards social housing but with the rates stagnating, I decided that I needed to look at other avenues to further boost cash flow in the business.
Having worked very closely with my broker, I quickly discovered that I could convert houses into HMO's with little money left in the deal after re-finance.
Portsmouth is also an area which is governed by Article 4 meaning that you have to get planning permission to change the use of the property from C3 residential to C4 (HMO planning use).
Having a vast amount of knowledge of the area, I have been able to purchase properties and look at planning gain in order to substantially increase their values (more about this to follow).
So for now, just the basics (as I have a varied bunch of valued blog followers) - HMO definitions & planning info noted below. You will see I have added the definition of an HMO according to how Shawbrook Bank will value it based on Commercial Finance - we work in boxes 3 & 4!
Proposed changes to licensing in 2017
- The Government is looking at making the following changes through secondary legislation to increase the number of properties subject to mandatory licensing.
- Remove the storey rule so all houses with 5 or more people from 2 or more households are in scope
- Extend mandatory licensing to flats above and below business premises (regardless of storeys)
- Set a minimum size of 6.52sq-m in line with existing overcrowding standard (Housing Act 1985) to close loophole created by upper-tier tribunal ruling
- The order is proposed to come into force in 2017, and there would be a grace period of 6 months for landlords to apply for a license
- Non-compliant HMO landlords will find themselves at risk of penalties of up to £30,000 at the end of this grace period
Those already subject to Additional Licensing will be able to passport in their license to the mandatory scheme free-of-charge during the grace period, but the same expiry date applies to the license.
2 - Sourcing the right property
It seems very self-explanatory but make sure you buy in an area of demand, ensure you have good local employment and good transport links. I have learnt from my mistakes, I took a punt on a few houses when I first started investing in HMO's that aren't in a typical room let area & although they do get filled it's never that quick and cash-flow is the name of the game (rooms sitting empty for months on end really hurts). Do your research, look at demand on spare room.
When looking for properties source through agents, I cannot express enough the gains of having a good agent on your side. We have got to the stage now where some of the agents we work with don't even bother doing viewings with us anymore, they just give us the keys to the property (often before it goes to market) so that we can go and assess the potential.
Another avenue is to source directly through HMO letters, don't forget the power of 'leafleting'.
Check the HMO register, there may be retiring landlords looking to sell off their portfolio. I was able to pick up a 22 bed HMO from a landlord who could no longer look after the running of such a large investment.
Join an HMO Facebook group, this is a perfect way for sourcing deals and the forums are fantastic for advice.
Once you've chosen an area, make sure you download the HMO regs from the council's website - every area has very different criteria.
When assessing the property, try and see what can be done via PD and how many en-suites you can get into each room. My MO for higher rental figures & demand is definitely an en-suite. This is why most of my latest HMO's will have an en-suite in almost every room. People will pay top £ in order to not have to share washing facilities - FACT! Please do bear in mind though that you will need building regs when installing a new en-suite so make sure you take that into account...
On building regs & refurbishment - the following work will most likely require approval:
- The erection or extension of a building
- An alteration involving work which will temporarily or permanently affect the ongoing compliance of the building, service or fitting with the requirements relating to structure, fire, or access to and use of buildings
- Installing replacement windows using a builder or window company which is not FENSA registered
- The installation or extension of a service or fitting which is controlled under the regulations
- The insertion of insulation into a cavity wall
- The underpinning of the foundations of a building
- When you want to change the building's fundamental use
- Renovation of a thermal element
- Change of a building's energy status
3 - Renting out your HMO/tenant target
* Advertisement/ Professional photography- you only have a small window to make your property stand out from the rest. We find that having professional photographs taken will enhance the advert & sell it before you even start viewings - this is a proven formula that we follow and it works.
* You can see the difference between a kitchen in one of our 8 bed HMO's that has been taken ourselves and then by a professional photographer - pay the money, it's worth it. It cost us £65 to photograph this entire HMO.
Professionals or Students - decide whether you want a group of Students or professional tenants. If you want students, rent out the house as a whole, to a group on one tenancy with a lead tenant rather than individually. This way if one tenant doesn't pay the rent, the others are jointly and severely liable to make up the funds.
Never mix students and professionals, as they lead two different lifestyles and it can cause conflict in the house.
4 - Viewings & dressings
book your viewings strategically, show them all available rooms. Sometimes tenants will tell you they have one budget, but then miraculously find more money when they see a bigger/better room. That being said if you have a smaller room in your HMO that's struggling to rent but also have a slightly bigger & nicer room to let in the same house, if you've showed them the smaller room and they seem to like it - don't show them anything else (the bigger room will always let out faster). Make a good impression as viewers have friends who will spread the word!
Always try to achieve higher rents! Don’t be unrealistic, but have a look on the market and see what other rooms are going for and how your rooms compare. Tenants will pay for quality. If your property it done to a higher standard, you can push for more rent.
As with professional photography, you only have a small window to advertise. Dressing a property will not only make it stand out from the rest on the websites, but when you take tenants round there for viewings, it looks more homely and they can visualise how all of their belongings will look and also get a better idea of size.
5 - Project build times & project management
Today I wanted to expand a bit about Project build times & project management. I think a lot of people under-estimate the work and time-frame involved in completing a project and therefore I want you to think about a few of these tips/points.
- If you're looking at a planning gain. You will need 10 - 12 weeks from the point of completion before you start work, factor that into your holding costs.
- Don't forget the contingency, so many people think they'll add a small percentage of around 5% but believe me this closer to 12%
- Ask your builder to sign a contract, where you clearly have staged payments for jobs completed. PLEASE vet your builder, if you have someone who is much cheaper but has no insurance, registered address etc. this can cause problems (do your homework). Make sure your builder is aware of the required building regulations as this is important. Add penalties if jobs run over (on a good faith basis though as building is weather dependent).
If you're doing multiple properties, get a refurb blue print. I would stick to the same kitchens, paint, flooring, carpeting etc. as it makes it so much easier from a maintenance perspective to source replacements at a later stage.
6 - Plan
PLAN, PLAN, PLAN! Fail to prepare, prepare to fail
- Prepare a schedule of works for the builders for when they visit the property to quote. It is essential at the beginning of the process that the builder is aware of exactly what you want.
- Be realistic with your builders and take advice from them. Rome wasn’t built in a day
- Plan out your rooms before starting the works, where the beds, bedside tables, wardrobes will be going, this will help with planning your electrics, plug sockets etc.
- If you are putting en-suites into rooms, be aware of waste. Check which way the floor joists run, find out where the soil pipes are, find the easiest route to the soil pipes from the en-suites.
- Have experts doing what they are good at, you will save yourself time and stress from having planning consultants and architects doing what they are good at - pay the extra for the correct team.