Falling profits on buy-to-let? Landlords converting family homes to student digs or shared properties for young professionals to boost rent
07-03-2016
By Sarah Davidson For www.Thisismoney.co.uk
Buy-to-let landlords have been hit by a barrage of changes in the past year, facing tax reliefs cuts, stamp duty bills hikes and a consequent clampdown on mortgage availability.
For many, particularly in London and the South East, the sums no longer add up on conventional property lets.
But some are finding ways to maximise rental income and improve profitability despite these headwinds - by converting family homes into shared accommodation.
Letting one property to multiple tenants can improve overall rental incomes without raising rents unreasonably
Usually landlords rent a property on the basis that one person or household is responsible for paying the rent, even where there may be a family of five residing in that home.
But increasingly, more experienced investors are recognising the opportunity to raise the overall rent earned from a property by renting to each individual or household living there separately.
An arrangement like this is more complex to manage, can require a licence from the local authority and generally incurs higher maintenance costs for landlords.
But it can pay off.
This type of buy-to-let is known as 'houses in multiple occupation' and while yields on a standard buy-to-let averaged 5.8 per cent in the first three months of the year, data from Mortgages for Business showed HMOs yielded an average of 10.2 per cent.
An HMO usually has four to six bedrooms, although the classification of this alters from council to council.
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BUY-TO-LET PROPERTY TYPES
Vanilla buy-to-let
These are standard buy-to-let transactions. Properties in this category tend to be normal two or three-bed houses and flats. Both borrowers and properties fit the general lending criteria for off-the-shelf products offered by the mainstream buy-to-let lenders.
Average yield in Q1 2016: 5.8 per cent
Houses in multiple occupation
An HMO is when unrelated tenants have exclusive access to their rooms and share part of the accommodation, such as the kitchen or the bathroom. Examples include bedsit style housing or student shared housing. An HMO may require a licence based on the number of storeys and/or the number of tenants, depending on the local authority.
Average yield in Q1 2016: 10.2 per cent
Multi-unit freehold blocks
This is a single building with multiple, separate, independent residential units owned under a single freehold title. Examples include purpose-built blocks of flats or Victorian houses converted into flats.
Average yield in Q1 2016: 7.8 per cent
Semi-commercial property
Also known as mixed investments, as both names suggest these properties are made up of part-commercial and part-residential elements, typically shops or offices with flat above.
Average yield in Q1 2016: 8.1 per cent
Source: Mortgages for Business
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Government regulation states that an HMO is at least three tenants living in a home forming more than one household, sharing a toilet, bathroom or kitchen facilities.
It becomes a ‘large HMO’ if it has more than five tenants and is over three floors.
Large HMOs automatically need a licence from the council and usually other rules also apply.
Chris Bramham, director of specialist mortgages and buy-to-let at adviser Brightstar Financial, said: 'For example, each bedroom will be let as a separate room and each will need a separate lock and a fire door, amongst other things.
'The biggest difference for the landlord between a property with multiple tenants and an HMO however is the way the tenancy agreement is constructed.
'With a shared occupancy in a building, there is one tenancy agreement covering all the occupants, no matter how many rooms a house has.
'An HMO on the other hand requires individual short-term tenancy agreements with each of the tenants.'
Understanding what is required of you as an HMO landlord is not always straightforward.
Ying Tan, of adviser The Buy to Let Business, said: 'There is still some confusion amongst landlords surrounding HMOs and I think this stems from the fact that not all HMOs require a licence.
'There is a general misconception that a property let to five or more people forming two or more households is an HMO while anything less is a multi-let but this isn’t actually the case.
'A property with just three tenants can be an HMO if those tenants form two or more households - in other words if they’re not related.
'HMOs with five or more tenants or where the property consists of three or more storeys require an HMO licence and I think there is where the confusion lies.
'A good guide is if there is more than one household and some facilities are shared it’s an HMO.
'There’s also a mistaken belief that only properties with individual tenancy agreements for each tenant are HMOs. Again this is not the case. An HMO can be let on a shared tenancy or individual tenancy basis and there are benefits and disadvantages to both.'
Higher returns and more tenants on the look out for shared homes
HMOs tend to be higher yielding, paying around 8 per cent or 9 per cent returns a year compared to around 5 per cent for a property with multiple tenants.
This is because the landlord gets a higher rate per room, especially for student accommodation.
In a four-bedroom house is possible to charge £600 a month for each room plus the use of shared facilities for example.
The same sized property let under a single tenancy agreement might only raise a rent of £1,200 a month by comparison.
WHAT CONSTITUTES AN HMO?
- An entire house or flat which is let to three or more tenants who form two or more households and who share a kitchen, bathroom or toilet
- A house which has been converted entirely into bedsits or other non-self-contained accommodation, and which is let to three or more tenants who form two or more households and who share a kitchen, bathroom or toilet
- A converted house which contains one or more flats which are not wholly self-contained (the flat does not contain a kitchen, bathroom and toilet) and which is let to three or more tenants who form two or more households
- A building which is entirely converted into self-contained flats if the conversion did not meet the standards of the 1991 building regulations and more than one third of the flats are let on short-term tenancies
- In order to be an HMO the property must be used as the tenants’ only or main residence and it should be used solely or mainly to house tenants. Properties let to students and migrants will be treated as their only or main residence and the same will be applied to properties which are used as domestic refuges
Source: Shawbrook Bank
Bramham said: 'As a result there is a real move by more experienced landlords to move into this sector.
'Experienced landlords who are used to dealing with multiple properties also have the skill set to deal with multiple tenancy agreements in an HMO and are benefiting from the higher yields.'
Demand from tenants for this type of shared housing is also on the rise, driven in large part by the slightly cheaper rents available to tenants renting a room rather than a whole property.
It is not just students looking to live like this either.
Figures from Spareroom.co.uk show only 31 per cent of UK adults living in shared accommodation can afford to rent on their own while renting in places like London can drain 50 per cent of tenants’ monthly income.
A recent report from Shawbrook Bank suggested there is a now large number of professionals seeking this form of accommodation for both financial and social reasons.
Emma Cox from the bank said: 'It is pushing landlords to put more thought and effort into their developments and is making this type of accommodation a more mainstream form of investment and housing.
'These enhancements take the shape of very high quality finishes, wireless access, flat screen TVs in communal areas and entrance ways - anything that gives them an edge in attracting the desired tenant profile.'
What to watch out for
Although the HMO market is increasingly catering for young professionals, the lion's share still offers housing for students.
This is both an advantage because of the ready supply of students in certain hot spots and a disadvantage, as large scale institutional investors have begun to build purpose-built student accommodation in university towns and cities recently.
In some student cities Cox said she is aware of 300 to 400 bedroom units being built for students and landlords with HMOs are being pushed out of the market.
She added: 'As demand has decreased it has also reduced the value and desirability of these properties and owners are struggling to sell them.'
The value of an HMO is a lot more vulnerable to significant fluctuations - especially where landlords have borrowed heavily
Cox also warned that less experienced landlords can over-estimate the profitability they expect from an HMO.
'Lenders are seeing an increase in traditional buy-to-let investors looking at HMOs as they are attracted to the perception of a significantly enhanced yield,' she said.
'However they may not be experienced in the management of HMOs and may not understand the operating costs and time involved.'
Due consideration should also be given to what sort of tenant landlords are targeting.
Cox said: 'One of the biggest headaches we see for investors is when they combine the “wrong” tenants which can lead to conflict and a serious escalation in management costs.
“ One of the biggest headaches we see for investors is when they combine the “wrong” tenants which can lead to conflict and a serious escalation in management costs.”
'There are also question marks on how sustainable the model is.
'Increased demand as the HMO route becomes a more mainstream avenue for investing can increase the risk of oversupply in some areas. In these regions there has been a trend for investors turning their HMOs back to single lets.'
There is also a heightened risk of being disproportionately hit by any rise in interest rates.
HMO valuations are usually predicated off a multiple of yields and rents with both prone to volatility.
The knock-on effect can be that the value of an HMO is a lot more vulnerable to significant fluctuations - especially where landlords have borrowed heavily to fund purchases.
Landlords with HMOs are legally required to ensure the property is safe and must adhere to a strict set of guidelines.
These include ensuring gas safety checks are carried out regularly and that there are adequate shared facilities for the tenants, for example fit-for-purpose washing facilities and a decent kitchen that is in a good state of repair.
If for any reason this isn’t the case with your property you’ll need to address it before turning it into an HMO.
You’ll also need to check whether the property requires an HMO licence, the cost of which depends on the size of the property.
Bramham said: 'A landlord will also need to look into building regulations for HMOs and how they need to adapt their property.
'This must lead them to question whether it is financially viable to switch a property from a shared house to an HMO, as there are some quite onerous regulations around HMOs.'
It’s also essential that you speak to your mortgage lender to check whether turning your property into an HMO would be a breach of your mortgage terms.
Tan added: 'Not all lenders are keen on HMOs because of the risks involved so make sure you check before making any plans.'
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CUT YOUR BUY-TO-LET COSTS WITH A BETTER MORTGAGE
If you are considering investing in property - or improving returns on a buy-to-let you already own - then taking advantage of record low mortgage rates could pay off.- Buy-to-let mortgages are slightly more expensive than residential loans and have different lending criteria, but rates are still near all-time lows.
- Getting a better mortgage will help save money on a purchase or could cut costs substantially for existing landlords.
- Check the best buy-to-let mortgage rates for you and how much they will cost using our mortgage finder service and best buy tables.
- This is powered by This is Money's carefully chosen partner London & Country, which can also offer fee-free advice to potential borrowers.
- For more help, read This is Money's Ten tips for buy-to-let - the essential guide to successful property investing.
Mortgage options are tighter
The two biggest buy-to-let lenders in the UK aren't keen on HMOs as they consider the risk higher than on vanilla buy-to-lets.
But there are a whole host of slightly smaller specialist lenders, nearly all of which are accessible through a mortgage broker, which offer competitive deals for landlords looking to purchase an HMO or repurpose an existing property to make it suitable as an HMO and who therefore need to remortgage onto a specialist deal.
Paragon Mortgages, Fleet Mortgages, Precise Mortgages, Axis Bank, Shawbrook Bank, Aldermore Bank, Foundation Home Loans and Kent Reliance all are strong in the HMO sector.
Most lenders go up to 75 per cent loan-to-value for HMOs with rates on two-year deals hovering around 3.79 per cent with a 1.5 per cent arrangement fee - although Kent Reliance will consider lending up to 85 per cent of the property value.
Paragon meanwhile offers a two-year fixed rate at 3.75 per cent up to 65 per cent LTV with a 1.5 per cent arrangement fee. The interest coverage ratio is 130 per cent stressed to an interest rate of 7 per cent.
This compares to its single let equivalent two-year fixed rate which is lower, at 3.4 per cent up to 65 per cent LTV with a 1.5 per cent fee. Rental income on this deal must be equivalent to 125 per cent stressed at an interest rate of 5.35 per cent.
By comparison, in the wider market a standard buy-to-let deal for the same style of product can be had for around 2.25 per cent with a £2,000 fee.
Mark Harris, of mortgage broker SPF Private Clients, said: 'HMOs and multi-lets are often subject to a higher degree of underwriting, subject to higher rates and lower loan-to-values.
'Some lenders take the view that only more experienced landlords should take these investments