River Source Properties Ltd (c) April HMO Property Investment Guide +44 (0)

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2 Executive Summary What is an HMO property? HMO stands for House in Multiple Occupancy and is usually defined as a rental property occupied by three or more unrelated people. Typically the houses will have lockable bedrooms with shared kitchen, bathroom and living areas. HMO tenants are usually: Students Young professionals Key facts: HMO properties can deliver yields as high as 13% net Choice of tenant types available to the investor Potential for up to seven year tenancy terms Growing market Asylum seekers Tenants on benefits Why should you be interested? There are four main reasons HMOs should be on every investors radar: 1. Above average returns up to 13% net 2. Lower risk by having multiple tenants and rent paid by the UK government 3. Growing sector 4. Easier exit as there are a number of options available to you We ll cover each of these in this document, as well as further investigation into what makes and HMO an Yours, David Ball Director Refurbished and tenanted properties available from River Source Properties HMO, the responsibilities of the landlord, and the Golden Rule when investing in HMO properties. High yields, long rental terms, lower exposure risk compared to single family properties and growth in line with the market make for a superb addition to your portfolio Page 2 of 10

3 Benefits of HMO investment There are four important reasons why you should be adding HMOs to your portfolio: 1) Returns can be above average for comparable, single let properties 2) Your risks are less 3) It s a growing sector 4) Easier exit Above average returns This is the main reason so many investors turn to HMOs. The simple truth is that you are able to charge more for the individual rooms split between different tenants than if you rent it to a single family. For example: We are big fans of HMOs where the rent is paid by the Local Housing Authority. The money goes from the local government, to the managing agent, to you. Effectively government money, so assured. Have a look at the rates allowable for Local Housing Allowance in Liverpool (one place where you can get net yields from HMOs in excess of 13%). If your HMO had four bedrooms let under one tenancy agreement, or Assured Shorthold Tenancy (AST) you would receive 150 per week (and probably the same on the open market to private tenants). The same property let with four ASTs - ie letting each individual room to a tenant unrelated to the others - as an HMO would receive 4 x per week = That s 48% more income from the same property Allowing for management fees of 8%, and a purchase price of 75,000 that s a NET return of 14.17% Less risk Like any investment, property isn t without it s risks. The main one of these being the tenant not paying their rent. I ve already mentioned our recommendation for mitigating this risk (and getting a great income) by letting to LHA tenants. However some investors might choose to let to private tenants, or students. In any of these situations, the risk of the rent not being paid is less than if the house was on a single AST. If one of the tenants is slow in paying the rent, you still have the income from the other three. If it s on a single AST and they don t pay, you re in trouble. Page 3 of 10

4 The reduction in risk is not only reduced for the rental income, it s also reduced for voids too. If the property is under a single AST and they leave, the property is vacant and you have no income from it. If the same property is an HMO and one of the tenants leave you still have the income from the other three. Even if two or three tenants leave you still have some income whilst the rooms are let, thus helping to smooth over the void period. And of course, in the right areas the single rooms will be easy to let again, thus reducing your void period simply because they are cheaper, and therefore are in higher demand. Growth market The demand for single rooms as part of an HMO is soaring and is unlikely to abate any time soon. A simple Google search will show up a number of research papers from local councils acknowledging this fact. This is great for investors looking for long term certainty of tenancy, particularly if thinking of renting to the private sector. As an investor you are sure to investigate local demand as part of your due diligence process. Whether you opt for private, student, LHS or asylum tenants it only takes a small amount of work to find out this information yourself. That said, we continue to favour tenants through the LHA and asylum routes for the certainty of income it brings either in the long length of tenancy as you will find with asylum investment, or in the form of consistent demand in certain locations in the UK, such as Liverpool. Whichever location or tenant type you opt for, your property will benefit from the same capital appreciation as other houses in the area. Easier Exit Anyone sensible in the property industry will tell you property is a long-term game. However at some point in the future you may decide to sell your HMO. What then? Well, above all else, you have a performing asset with a demonstrable track record. If the price is right you should be able to find another investor who would be happy to buy it from you. Speak to your letting agent, they have a captive audience of landlords who have properties in the same area. Someone is likely to be interested. Of course you could wait until all the ASTs have expired and sell it as a house on the open market. The choice is up to you and you are not limited in anyway. Page 4 of 10

5 Asset Class Review The Golden Rule for HMO Investment Like most investments there are a number of rules you should always be aware of when considering getting involved. With HMO properties, it s this: Always make contact with the HMO Officer from the local council where the property is located, and describe the property you are buying and, if required, register the property with them. This is a more important rule than it might first appear. Believe it or not there are substantial regional variations between the rules for HMOs in the UK. It is essential you abide by those rules, because as the landlord you are liable to prosecution if they are not adhered to. These rules are not onerous, and in fact are common sense, but this simple exercise will ensure you are not in line for any issues. The areas the HMO Officer will want to discuss will include the property itself, how the property will be managed, and some basic information about you. They will confirm the standards that are expected in the region, and confirm whether or not the property needs to be licensed. Depending on the location and property type, it s very possible that you might not need to register with them at all, but it s sensible practise to get in touch with them to confirm. More on HMO licensing In Liverpool, you will not need a license for your HMO unless the property has five or more bedrooms, or is over three or more floors (including the ground floor). In Manchester and Salford, all HMOs need to be licensed. We think it s reasonable to assume that it s just a matter of time until all HMOs in all locations will require a license. It s a great way for a local council to raise funds after all, and you should bear this in mind if the property you are considering does not yet require a license. The requirements from an HMO licensee follow common-sense guidelines, but failure to comply could result in prosecution and fines. Expectations include: All tenants have up to date assured short hold tenancy agreement All gas and electrical safety certificates are in place Safe furniture and appliances All smoke alarms and fire safety equipment is in place and fit for purpose (read the LACORS guide which is available by following this link) Maintain records of all works carried out on each property Page 5 of 10

6 Test emergency lighting every six months Arrange for annual independent testing of fire alarms and safety equipment Annual tests of all self-closing doors Carry out remedial maintenance to anything which could pose a health and safety risk to the tenants, e.g. Loose banisters Loose carpet on stairs Clean water supply and effective drainage Secure fences Provide ability to store and dispose of waste Our view is that all of the above are sensible measures whether your property is an HMO or not, and will help to ensure long-term tenancies with as few issues as possible. There are also clear expectations from the tenants: Take suitable precautions to limit the chance of fire Assist the property manager to access the building and carry out their work Dispose of waste Avoid damaging the property, and repair any tenant damage as appropriate Which tenancy type? You have four options when thinking about which type of tenant you would like in your HMO property. You should really have decided this before buying the property following your own due diligence as it s the most critical area to analyse. After all, it s the source of your income for your investment There are four types of tenant you will want to consider: 1. Private tenant 2. Students 3. Asylum seekers 4. Local Housing Allowance (LHA) tenants Page 6 of 10

7 Let s consider each one with the following categories, yield potential, term of contract, likelihood of this contract to be renewed, certainty of rent payment, and how well the property is likely to be cared for. Private tenant Yield potential: Good, providing property is in the right location for their interests and is well presented. Term of contract: Usually 6-12 months at a time. Renewal likelihood: Medium. You should expect that private tenants will be working towards buying or renting a property of their own, without having to share. Expect 1-2 years per tenant at best. Rent certainty: Above average. Tenants usually want a good reference for the next property they will be moving to, hence need to ensure prompt payment of rent. Rent insurance recommended. Property care: Good. The property is likely to be well looked after. Students Yield potential: Medium to good for quality properties. Although price-sensitive, students tend to be choosy about the areas they live in and the finish of the properties meaning you can charge a higher rate than student digs. Term of contract: Usually months at a time in line with the academic year. Renewal likelihood: Average. Students tend to rent with friends they develop over their academic careers, and often move to different parts of the city over time. However a good property will always be in demand. Rent certainty: Good. Providing the landlord uses a letting agent with experience letting to students there should be in place a guarantor, usually a parent. Rent insurance recommended as further back-up. Property care: Good. Like private tenants, students need a reference for renting after their first year, plus they generally don t want the bond which has been put up by their parents to be spent. Asylum Seekers Yield potential: Medium. Expect 9% net (which is still high compared to investing in single properties) Term of contract: Contracts are not with the tenants, but a government appointed agent for up to seven years. Renewal likelihood: High. Qualifying properties are in high demand by the government agent as they are restricted by postcode and property type. Rent certainty: Guaranteed. Income comes from the UK government via it s agent whether or not the property is tenanted for the full term. Page 7 of 10

8 Property care: Good. The properties are visited up to three time per week as the agent also carries out a similar service to a social worker for the tenants, as well as keeping an eye on the property itself. The properties tend to be well cared for as the asylum seekers are wanting to give a good impression as part of their asylum application. LHA (Local Housing Allowance) Yield potential: High. Letting individual rooms in the right location will generate high yields over 13% net. Term of contract: Usually 6 month ASTs. Renewal likelihood: High. Tenants on LHA benefits are less likely to move around and will settle for longer, especially if the property is well-finished and maintained. Rent certainty: Guaranteed. Income comes from local government in the form of Local Housing Allowance direct to the landlord via the letting agent. Property care: Average. The tenants that we prefer for HMOs are students, asylum seekers, LHA tenants. Each is a specialist area that we are able to assist investors with. Page 8 of 10

9 River Source Properties Ltd (c) April 2014 Sample property - before and after At River Source Properties we offer renovated properties for students, asylum seekers and LHA tenants. Before and after example below: Page 9 of 10

10 Next steps Continue your investigation into the highly profitable HMO asset class We have a number of blog articles which you can access at blog.riversourceproperties.com where you will find further free resources such as this guide. If you would prefer to get in touch now, please do so using the contact details below. River Source Properties provides free guides like the one you are reading, and our choice of what we believe are the best income generating property investments in the UK for private landlords. As part of this selection, we offer HMOs with student, LHA and asylum tenants. Talk to us about how this could fit into your portfolio David Ball River Source Properties Ltd david@riversourceproperties.com More details about River Source Properties Ltd and the people behind the company, together with the full terms and conditions of working with us, can be found at our website: Disclaimer: The contents of this document are the authors own opinions, and should not be relied on for your own investment decisions. Investors should always do their own due diligence, and take independent advice. Copyright: Feel free to share this document, but please don t copy the contents without our consent as this would constitute a breach of our copyright. Page 10 of 10