An HMO stands for House in Multiple Occupation. It refers to a property shared by three or more tenants forming two or more households who share amenities like bathrooms or kitchens. This type of housing often offers higher rental yields compared to single-let properties but comes with stricter regulations and management complexities.
What is HMO?
HMO stands for House in Multiple Occupation. It refers to a property shared by three or more tenants forming two or more households who share amenities like bathrooms or kitchens.
Definition
Each of the following must apply:
(a) A single dwelling occupied by 3 or more tenants; and
(b) Forming 2 or more households; and
(c) Where the tenants must share at least one amenity
“Household” – Relatives in the broadest sense and people living together as ‘married’
“Amenity” – toilet, bathroom or kitchen
The dwelling may be a house, may be a flat (if self contained) or a building with no self-contained flats, or a converted building of any kind with any of the above dwellings within.
Converted Self-Contained Flats in a Block
HMOs if conversion building work did not comply with standards (and still does not comply) & less than 2 thirds of the flats are owner occupied (a technical point for fire safety).
HMO Declarations
The Council is able to make a declaration that a property is a HMO.
House Sharing
If the landlord resides in the property it is not a HMO if the other occupants (excluding the landlord’s household) are limited to 2 other individuals.
Licensing
Not all HMOs need a licence. Some must have a licence under law (mandatory), others may need a licence based on the local council requirements (additional or selective), others may remain HMOs but not require a licence.
Definition
Licensing is per property, not per landlord. ALL HMOs in Scotland & Northern Ireland must be licenced. The discretionary element of licences only applies in England & Wales. Licensing is self certified so can be revoked.
Mandatory
A licence is required for ALL “Large HMO” properties; defined as meeting all the following:
(i) Occupied by 5 or more people (with rent being paid by at least one party); and
(ii) Contains 2 or more households
(iii) Tenants share any amenities
Additional & Selective Licencing
At the discretion of councils, if HMOs give rise to problems, the council may insist property in a specific geographic area (selective) or a type of property (additional) to be licensed.
Further details
Applying for a licence requires the notification of all parties with an interest, including the mortgagee but this does not include tenants. Licences last for a maximum of 5 years and you must not allow the licence to expire. Inspections of property can occur at any stage.
October 2018 Rules Changes
Pre-Oct 2018, Large HMOs needed to be on 3 storeys or more. This element was removed completely, broadening the definition. In addition, new mandatory licence conditions were released.
New Mandatory Licence Conditions (Oct 2018)
There are 2 main additional conditions.
(a) Minimum Sleeping Room Sizes
These including only space 1.5m high or more, note that councils can insist on higher standards.
• 6.51m squared for 1 person over 10 yrs old.
• 10.22m squared for 2 people over 10 yrs old.
• 4.64 m squared for one child under 10 years old.
(b) Waste
Suitable waste storage facilities and compliance with the council’s waste policy.
Transitional Arrangements
Properties with an existing licence (of either kind) will have a transitional provision that grants them the ability to only apply the extended mandatory licence conditions (min room size and waste)from the renewal date. On renewal, the licence holder will have up-to 18m to become compliant with minimum room size requirements (time set by council).
Celtic Nations
The laws are not the same across the home nations. This focuses on England but there are small differences elsewhere.
Wales
Since devolution, there are differences in building regs though these are predominantly minor. There is also a requirement for every landlord with property in wales to register under Rent Smart Wales, essentially a mandatory registration log.
Northern Ireland
HMOs need to be registered and minimum room sizes and age limits are slightly different.
Scotland
All HMOs need a licence via the council and they last 3 years.
HMO AND Licensing Implications for Mortgages
Tenant
Drawbacks
Typical occupants are students, lower income earners or those claiming benefits; both are out of favour with some lenders as a source of income supporting mortgage repayments. There may be asylum seekers which may also rule out some lenders. The nature of house sharing is that it can often be for a short period of time, giving less security of income. Furthermore, tenants are less likely (based on market perceptions and possibly experience) to maintain the property well.
Positives
As the property typically consists of multiple tenants, any issue with one is mitigated by others (“Portfolio Risk”). E.g. if one tenant does not pay, you still earn from the others rather than earn no rent at all. Also, the rental income earned per square foot of space occupied is greater, mitigating some of the greater risks with a greater return.
Positives
As the property typically consists of multiple tenants, any issue with one is mitigated by others (“Portfolio Risk”). E.g. if one tenant does not pay, you still earn from the others rather than earn no rent at all. Also, the rental income earned per square foot of space occupied is greater, mitigating some of the greater risks with a greater return.
Compliance
The landlord has additional compliance regulations to adhere to and there is always a risk that the property requires or will require a licence in the future. This is a significant additional risk to a lender as it directly affects the landlord’s ability to generate income from the property and thus pay the mortgage. In addition, the same would be true were the lender to repossess the property.
Planning & Valuation
Restrictions on supply affect price, in the case of HMOs and mortgages, valuation and rent. Any limited on the availability of HMO licences or property numbers will have a significant impact on valuation. It is not just licencing but planning that controls this local supply. Planning controls can be implemented to control HMO property supply. Whether planning or licence restrictions are in place will impact rent and valuation and thus be key to mortgage lending.
Planning
Property Classification
A single dwelling that can be considered a private residence or ‘standard’ BTL is classed as a C3 property. A C4 property is a dwelling that is used as a HMO as defined previously. No planning permission is needed to convert a property from C4 to C3 and also, unless the Council has introduced special restrictions known as Article 4 Direction, there is no planning permission required to change the property from C3 to C4. This is distinct from licensing.
Article 4
Article 4 restricts the ability to create /convert property into HMOs using planning restrictions and as such affects the market for these properties by limiting demand. Typically this will increase price by reducing supply (and therefore opportunity). Article 4 therefore has wide reaching impacts on investments and valuations (see below). If you already have C4 and Article 4 is out in place you do not have to re-apply. Note that if you have C4 permission on a property and convert use to C3, you lose automatic rights to C4 if Article 4 is in place, i.e. you have to re-apply.
Sui Generis
Sui Generis planning permission is required for converting property into a dwelling for more than 6 unrelated individuals. Note that this is a different threshold to Mandatory Licencing though all Sui Generis will require mandatory licensing the same does not apply vice-versa as Mandatory Licencing is more than 5 tenants. Again, this level of planning permission has an impact on the market dynamics of supply and demand.
Some C4 properties have been adapted to ensure there are multiple sets of amenities, provide fire escapes and to comply with health and safety. This limits future use to HMO provision and thus limits the market for re-sale. These properties are classed as C4 but thanks to the conversion works may command a premium as the works have been done. Equally, they may be worth less if the demand for HMO property is poor or if there is no Article 4 market restriction.
Valuations
Valuation Methods (Generic)
There are five methods of property valuation:
(i) Comparative method (Standard, Comparable, OMV, Bricks & Mortar, Building Value)
Comparing the property with similar properties. Standard for the majority of scenarios.
(ii) Investment method
Uses the incoming producing nature of the asset so uses expected income and equates this to a risk relevant risk weighted return to provide a multiplier for the valuation.
This method is often used in commercial valuations, as well as HMO valuations. Yield is calculated as Net Yield or Gross Yield less an assumption of ‘costs’ of 25%-30%. Rent is usually based on 50 weeks.
(iii) Residual method
This is used to establish the valuation of development sites and takes the cost of developing the land and the final gross development value to assign a value for the land.
(iv) Profits method
Used more as a valuation for a business premises, such as hotels and cinemas. Using profits rather than rental yield.
(v) Replacement cost method
This is reserved for buildings with little comparable evidence, such as churches, schools, etc. The cost of the land & the cost to rebuild are the basis of the valuation.
For some property developers there will be a need to understand the Residual method of property valuation. For commercial investors and HMO investors, the Investment method will be applicable. For every other type of property investor, simply understanding the Comparative method will suffice.
HMO Valuation Methods (Examples)
(i) Standard Property used as HMO (C4 Standard)
No discernible difference between C3 so “Standard” Comparable Valuation.
(ii) Converted Small HMO with no Article 4 Restrictions in Area (C4 Converted)
Up to and including 6 possible unrelated tenants. Possible favourable valuation based on conversion but a function of demand in the area. Favourable valuation limited to only a proportion of conversion costs otherwise worth investors buying C3 & converting.
Likely a typical lender will value on a C3 Standard Comparable Basis but a chance of being at the slightly higher end of the C3 Standard Comparable Valuation band if:
(a) HMO demand is high, and
(b) Cost of conversion is material.
May be lower than C3 Standard Comparable Valuation if HMO demand is low as cost of reconversion to C3 is deducted.
(iii) Converted Small HMO with Article 4 Restrictions in Area (C4 Converted & Restricted)
Up to and including 6 possible unrelated tenants. The Article 4 planning restriction has created scarcity and thus the converted C4 property has a premium in so far as there is demand for HMO property in the area. On the assumption that there is strong demand for HMO property then the property will be valued on the Commercial Investment Valuation which will be based on yield.
If the HMO demand is low then the property will be valued at C3 Standard Comparable Valuation less the cost of conversion. This is rare, typically the demand affects value through lower rental yields.
(iv) Converted Large HMO (Sui Generis Standard and also Sui Generis Restricted)
Valued using the commercial investment valuation based on yield. If restrictions are in place then, assuming demand is high, rental yields are more secure so valuation should be affected accordingly.
Lender Instructions
Understanding the way a lender classifies a property is crucial. ALL methods discussed are valid but each lender will have its own valuation policy and will instruct the surveyor to assess the security subject to specific criteria. A lender may value a converted property as a C3 with a premium for conversion, others may apply a basic C3 valuation, others may down grade the valuation by the cost of re-conversion. Whether the lender takes a different approach in the event of Article 4 restrictions or not is also important and each lender will look at it differently. Market demand will also be crucial. Same for Sui Generis.
Commercial v BTL
For the above reasons, HMOs are seen as the start of commercial lending and treated differently to ‘normal’ buy to let (BTL) lending due to the extra complexities. Higher rates are therefore expected and terms can also be less favourable.