The controversial but lucrative tactic of chopping up family homes into bedsits or “houses of multiple occupation” (HMO) is no longer the biggest earner in buy-to-let.
So-called "multi-unit freehold blocks", which involve buying a block of flats or a converting a building into apartments, earnt investors 9.3pc in gross rental yields between October and December 2014.
By contrast, HMOs, the buy-to-let formula of millionaire property investors like developer Jim "HMO Daddy" Haliburton, earned 9pc in the same period.
These yield figures, based on thousands of actual transactions made since 2011 through leading buy-to-let broker Mortgages for Business, are “gross”. That means they don’t take into account costs such as servicing a mortgage, maintenance costs, ground rent – or add-ons such as letting agent fees and income tax.
The chart (below) compares rental yields across buy-to-let investment in blocks of flats, HMOs, and mainstream buy-to-let which usually involves a two or three-bedroom house or flat.
Investing in blocks of flats doesn’t come cheap. Prices start at around £500,000 for an eight-apartment building in a city outside London and £4m for the same size building in central London.
However, the average buyer’s budget for a block of flats has fallen in recent years. In early 2011, the average property price was £932,148 with a 44pc deposit. Now, investors pay £497,644 on average with a 36pc deposit.
Typically, landlords rent out the flats to individual tenants, charging rent for the individual flats and a ground rent.
Currently, investors can buy a converted Victorian home with eight flats in Nottingham, on the market for £475,000, which currently yields 7pc, according to online property portal Rightmove. A luxury development of 20 apartments in Canary Wharf, London, recently sold for £33m.
HMO will continue strong performance, experts say
HMO rental yields are higher than more traditional buy-to-lets, but returns have slipped over the past year. Slicing up properties for multiple occupants, where tenants share a living space but hold separate rental agreements, yields 1.4 fewer percentage points than at the same point last year.
For the year ahead, buy-to-let investors are confident that HMOs will produce the best income.
"The fact that yields on multi-units have overtaken HMOs is surprising but can be attributed to a larger proportion of transactions for larger multi-units in the quarter," said David Whittaker of broker Mortgages for Business.
Multi-unit flats are lucrative because of "economies of scale" and therefore may only benefit high value investors.
Meanwhile HMO remains popular with high demand from tenants. "For a multitude of reasons, not least stagnant wage growth for half a decade, many tenants simply can’t afford an enormous flat with a spare bedroom," Mr Whittaker said.
"As such, the attraction for many of renting a room rather than whole property will ensure that there is a steady yield-boosting demand for HMOs over 2015."
The average residential rent across England and Wales is now £767 per month, up from £745 in December last year, according to estate agent chains Your Move and Reeds Rains.
The gross yield on a typical rental property in England & Wales is 5.1pc, while the average capital gain amounts to £10,546.