HMO properties and how to secure mortgage finance

While the UK government has been relentless of late with regards to increased regulations and taxes for the buy to let market, there is still significant interest in the HMO (houses in multiple occupation) sector. This is an area of the UK property sector which has increased exponentially in recent years as property investors are drawn in by the potential of double-digit rental yields. We will now take a look at various issues surrounding HMOs and the numerous opportunities to source funding.

What is the definition of an HMO?

Those who follow the HMO market will be aware that the UK government has periodically changed the definition of an HMO. The idea was simple, to bring together any houses in multiple occupation under one regulatory and taxation umbrella. That way, any changes introduced in the future would instantly reverberate right across the sector.

At this moment in time a basic HMO, compared to a large HMO, is defined as:-

• One with at least three tenants forming more than one household
• Including shared facilities such as a bathroom and kitchen

Prior to October 2018 a large HMO was defined as:-

• Occupied by a minimum of five people
• Consisting of two or more separate households
• Taking in at least three stories of a building

These rules were simplified in October 2018 with large HMOs now defined as:-

• Forming two or more households
• Occupied by a minimum of five people

Historically it is larger HMOs which have attracted the greater costs including licences for landlords. However, as we tend to see with all growing markets, local authorities have been given a significant degree of interpretation with regards bringing smaller HMOs under their licensing laws. This has and will continue to bring in significant revenues for both local authorities and the UK government.

How large is the HMO market?

As we touched on above, there has been huge growth in the UK HMO market as property investors see the opportunity to secure double-digit yields going forward. In all honesty this market has been fed by an inadequate new build policy from the current and previous governments going back decades. As demand for private rental properties continues to grow, investors continue to push house prices higher and higher forcing more first-time buyers to revert back to the private rental market. This then creates something of a vicious circle and one which it is difficult to see being broken in the short to medium term.

At this moment in time the combined student/professional UK HMO market is now worth in excess of £20 billion. Despite the emergence of a recent trend, seeing more young adults living with their parents until age 25, the demand for HMOs and private rental accommodation as a whole is extremely strong.

Encouraging larger entities into the HMO market

There has long been a suspicion amongst property experts that the UK government would prefer to have a much smaller group of private landlords (companies) as opposed to the raft of independent private landlords we have today. While there has been no direct comment on this suspicion it is safe to say that the actions of the government speak louder than their words (or lack of them). In recent times we have seen:-

• A significant expansion of tenant rights over and above those of landlords
• The phasing out of mortgage interest relief for higher rate taxpayers
• A reduction in allowable adjustments for wear and tear
• The introduction of a 3% stamp duty surcharge on second home acquisitions

It is not difficult to see how these taxes and changes have been targeted at individuals as opposed to companies. The fundamental basis upon much which companies are based is the ability to offset all costs against all income. Therefore, for example the reduction in mortgage interest relief for higher rate taxpayers would have no impact upon the way in which mortgage expenses are currently offset within a company wrapper.

Raising HMO finance

We recently saw UK base rates reduced by 0.5% to a record low of 0.25%. As a consequence, those investors who were undecided about entering the HMO market have certainly had their heads turned by the offer of cheap finance. However, when looking to raise finance to purchase HMO assets there are a number of issues to take into consideration:-

LTV ratios

At this moment in time you will require an absolute minimum 25% deposit against the cost of an HMO property. As a consequence, the maximum LTV ratio available is around the 75% mark. There are some companies who will require a minimum 40% deposit resulting in an LTV ratio of just 60% but the exact terms will depend entirely on the individual’s circumstances.

Interest/rental cover

HMO mortgage lenders will look at both interest cover and rental cover when calculating the affordability of an application for funding. Typically the interest cover ratio would be anywhere between 3.5% and 5.5% (in practice an assumed worst-case scenario mortgage interest rate) with rental cover typically between 125% and 145%. This effectively means that rental income would need to be up to 145% greater than the interest payments on a HMO mortgage.

Investor experience is vital

While not necessarily set in stone, many HMO lenders would prefer their clients to have at least some hands on experience of running HMOs before securing finance. This is an industry which is in theory relatively straightforward, buy a property and find a tenant, secure contracts and watch the money roll in. In reality there are so many other issues to consider such as legal costs, HMO licences and rent arrears together with conversion costs for many properties.

Are mature landlords welcome?

We live in a world where risk/reward ratios dominate the financial markets and the release of capital. Therefore, you would be forgiven for assuming that landlords in their older years may find it easier to source investment capital because of their life experiences. Well, the reality is that mature landlords over 60 years of age may find it difficult to secure the finance required. As with traditional mortgages, it is as much about their age as their perceived ability/inability to bring in regular income for the term of a mortgage arrangement.

HMO lending specialists

The ongoing growth of the UK HMO industry has created a mortgage market subsector dominated by HMO lending specialists. They can in theory accommodate the vast majority of varied scenarios taking into account age, income, experience and other factors mentioned above. Obviously, the headline mortgage rate would reflect the perceived risk/reward ratio so it is very important to shop around when seeking finance. Indeed many HMO investors now employ the services of mortgage brokers who are able to utilise their own contacts in the marketplace to secure exceptionally competitive terms and conditions.

Conclusion

There is no doubt that the UK government is hellbent on transferring the vast majority of HMO assets in the UK to a relatively small group of corporate landlords. The introduction of punitive taxes and regulations targeted specifically at individual private landlords has been brutal. There were initial hopes that Boris Johnson would repeal a number of changes brought in by Theresa May but what with Brexit and the coronavirus pandemic these hopes have been diluted somewhat of late. So, we have a growing HMO market in the UK, specialist lenders and while the returns for private investors have been reduced of late, there is still the potential to lock in double-digit yields.