Commercial Watch: Multiple causes for optimism in HMO sector

Doug Hall - 3mc

As HMO landlords focus on young professionals, pricing has become more competitive and the sector continues to grow

The HMO market has gone from strength to strength over the past year and there are good reasons to believe this trend will continue.

First, landlords are seeking higher-yielding investments as returns from the mainstream market continue to come under pressure. HMOs generate more rental income and there is less dependency and risk for the landlord if their income is derived from several sources.

Second, HMOs are popular not only with student and social tenants but also with a growing band of professionals. These tenants choose HMOs because of not just lower costs but also lifestyle factors including location, proximity to transport links and a desire to live in a more communal environment with like-minded friends.

These developments have driven changes among both landlords and lenders. Landlords are starting to develop properties for the young professional market, with high-quality finishes, internet access and wide-screen TVs in communal areas. They are therefore seeking properties capable of being converted into accommodation for typically six to nine tenants.

There is also a new generation of landlords who have focused to date on the traditional market but are now branching out into HMOs.

Landlords in this sector must consider certain factors. HMOs may generate higher yields but they take more time, effort and cost to manage; it is not untypical to allocate 25-30 per cent of rental income to management and maintenance costs. Landlords must also learn how HMOs are categorised and the rules on licensing and planning permission.

The latter are not connected so investors must understand both, especially if seeking a mortgage.

Technically, a home becomes an HMO if occupied by three or more people forming two or more households, where more than one household shares amenities such as a toilet, bathroom and kitchen.

The Town & Country Planning Act 1990 states that any change of use of a property requires planning permission, unless it is ‘non-material’ or allowed by General Permitted Development Orders, which are based on the following classifications:

  •  C3 dwelling house: a normal house or flat occupied by a single person, couple or family
  • C4 house in multiple occupation: a normal house shared by three to six unrelated individuals as their main residence. They share facilities such as a lounge, kitchen and bathroom
  • Sui generis HMO – a larger property that cannot be classified as C3 or C4 and accommodates seven or more unrelated individuals.

For HMOs it is permitted to change use from C3 to C4 (and back again) unless an ‘Article IV’ direction is imposed by a local authority. Change of use to a sui generis HMO does require planning permission.

If a property is let to five or more tenants and has three or more storeys with a shared kitchen, bathroom or toilet, a mandatory licence is required. Some local authorities limit the number of HMOs in a particular area.

Lenders have also responded to the emerging HMO market, as the table shows. When I last wrote about the sector for Mortgage Strategy in May 2015, the average pricing across the six lenders on a chart within that article was 5.36 per cent.

The average pricing across the seven lenders shown in the chart opposite is 4.07 per cent. While not an exact comparison, it shows that pricing has become more competitive in this sector.

I am sure more lenders will respond to the growing interest in HMOs. This is a market for brokers to watch carefully.

Doug Hall is director of 3MC