Houses in multiple occupation: true running costs
Some serious considerations
15 February 2017
Peter Foulds looks at the true costs of running an HMO
So your client, having heard all the dinner party chit-chat about the great buy-to-let opportunities, dashed out to secure a great deal on a house in multiple occupation (HMO). This client is seduced by the prospect of a potentially good income: there are multiple tenants, which will reduce the risk of the property falling entirely vacant. Repairs should be pretty straightforward, too, and as the landlord, they can easily call round at weekends or evenings to change the lightbulb in the communal living area or clear out that blocked drain.
They tell you that the costs can be easily controlled. There was some additional expense in buying the house with the increased stamp duty, but they have accounted for all other outgoings in the budget. Or have they?
Imagine the unfolding scenario for the inexperienced investor, who is beginning to have doubts about whether their budget analysis is up to scratch.
Your client says:
'I don’t quite understand the HMO licence arrangements and had assumed that as the previous owner had a licence, this would cover my ownership. But I was wrong. My local authority charges £870 for a 5-year licence.
'I had also assumed that because the property had been granted a provisional licence, this would automatically be renewed. In fact, it had not been inspected by the council and I now understand that there are works required to make the property safe. Apparently, it assesses the property against something called the Housing Health and Safety Rating System that judges the property against 29 housing hazards, including food safety and intruders.
'Never mind, at least I’ve put up some smoke detectors, which should sort out the fire risk issue. I am a bit concerned, as my friend who also owns an HMO came for dinner last night and was talking about a minimum space requirement for each bedroom and class A or D mains-linked smoke detectors, with minimum 30-minute fire doors. They also said stairs must lead directly to the final exit without passing through a risk room. I’ll ask my local builder to put up some extra plasterboard partitioning. That will sort it – won’t it?
'My friend then started going on about Legionnaires’ disease and testing the water appliances. Don’t know what this is about, isn’t it someone in the French army? Anyway, the plumber wants to charge me 50 quid and has also told me that it will be £100 to do the annual gas safety check. But then he cannot do the electrical check that my local authority requires. I do know about the furniture, though, and I made sure that it has all the right fire tags on it.
'But why do I need to install a carbon monoxide alarm? It all just seems like unnecessary red tape. Surely it does not apply to me, and in any event they will never catch up with me if I cut a few corners, will they?
'I have to admit I am now getting worried and wake up at night in a cold sweat. Everyone told me it was dead easy. Buy an HMO and you will get at least 10% return on your rental income. Brilliant, I thought. But what about all the costs I keep hearing about? How do I take them into account?'
Expert advice sought
Your client continues:
'I wish I had taken more advice and talked to a buy-to-let specialist surveyor when I first had this idea. But even if the rent has to be used for some of these works, at least it’s always going to come in – right? I mean there won’t be voids, will there?
'I can always sue a tenant if they trash the place, and I am sure my local builder will be able to fix it up for me if there are problem occupants, won’t they? Do I need to pay the council tax if the tenant does a runner?
'The mortgage valuer has been today – I bought the property for cash at auction – and, boy, did they ask a lot of questions. They seemed a real stickler. You know how these surveyors can be.
'Not only did they want a copy of the licence, they measured every room and wanted to see the assured shorthold tenancy – my arrangements are a little informal – so that was tricky.
'Then they told me that the humanities department at the university was being relocated to the other side of town, and asked if I expected to have to drop my rents to fill the house next year! What do they know, though? I mean all they have to do is take the rent and multiply by 10 – I think.
'I suppose I could take the easy route and get someone to manage the property for me. Those tenancy deposit schemes are becoming a pain in the neck, and the inventory was always wrong. But my mate gets charged 12% of the rent he receives, and what do those agents do for that? Then again, it would stop the nightly phone call about the broken toilet.
'Now I hear that the tax relief is going to change so I cannot offset my mortgage payments, and wear and tear allowances have been reduced as well. On top of that, I’ve heard about the Deregulation Act 2015, the Housing and Planning Act 2016 and further moves by the Bank of England to regulate the sector. All of this eats into my margin.
'But it will be all right in the end, surely? House prices are always going to increase … aren’t they?'
The point about this nightmare for our fictional landlord is that they have not thought about the real costs of running an HMO. Councils are becoming very efficient at managing the HMO question in their areas with licensing and enforcement.
When considering a purchase, all relevant costs have to be taken into account. Voids need to be reflected and appropriate deductions made when considering the true return on investment. Changing the communal lightbulb yourself represents a very different cost from employing an electrician who has a minimum call-out rate.
Any surveyor who is involved in buy-to-let and HMO valuation work must be suitably experienced in the local market from both a capital and rental perspective, as the rental assessment is equally important in the estimation for mortgage underwriting purposes.
A sound understanding of the local and national regulatory framework is essential, so the surveyor is able to comment on local conditions such as room sizes, selective licensing schemes and planning restrictions, including Article 4 directions, that can be so critical to value. If an investment approach is to be considered, then does this result in a valuation that is out of kilter with the local market? In reality, can the investor just buy the large family house next door and convert it into a 5-bedroom HMO?
If you are adopting a yield-based approach, then you must take care to ensure comparables are considered on a similar basis. In other words, you must value as you devalue. Are comparables let on a gross or net basis?
These are considerations that have been predominant in the residential buy-to-let market, and represent an area in which RICS has been keen to give guidance – in fact, the valuation of buy-to-let and HMO properties guidance note is now published and is an essential read for any surveyor wishing to operate in this field.
Peter Foulds is Director of Risk Management at Allied Surveyors and a contributor to The valuation of buy-to-let and HMO properties guidance note