Should you invest in an HMO?

Houses in Multiple Occupation (HMOs) can provide a lucrative investment opportunity. As with any investment, however, there are potential downsides to consider.

To explore further, Portfolio8, specialists in buying and selling tenanted properties, share their insight into investing in an HMO.

What is (and isn’t) an HMO?

Before looking at the pros and cons of investing in HMOs, it’s important to be clear on what an HMO is (and hence what it isn’t).

An HMO is a property that is rented out to three or more people who are not from the same household but share common facilities.

There are two key points to highlight in this description. Firstly, the deciding factor in whether or not a house is considered an HMO is the number of households. This can be different from the number of tenants.

For example, a two-bed flat shared by four people renting together or as two couples would not be an HMO. This is because there would be one or two households rather than three.

Secondly, a house is only an HMO if tenants share common facilities such as kitchens or bathrooms. A larger house subdivided into self-contained studios would not be considered an HMO because each household would have its own facilities.

Pros of investing in HMOs

The reason why HMOs are still popular with investors is that they have very specific benefits. For some investors at least, these can be more than enough to counterbalance their drawbacks.

Higher rental yields

The demand for HMOs means that they can often be priced to generate very attractive yields. Realistically, this demand is highly likely to decrease any time soon (if ever) because HMOs offer a low-cost, low-hassle route to renting independently.

In fact, for some people, especially young adults, an HMO may be their only option. They will simply not have the rental/credit history to get other types of property. Renting in an HMO is therefore an essential first step for them.

Diversification of income

For most property investors, investing in HMOs diversifies income in two key ways. Firstly, it gives them a presence in a new part of the property market. Secondly, it means that a single property can be used to generate multiple sources of income. This means that it is much less likely that a property will not generate any income at all.

In particular, HMOs place investors at much lower risk of having to deal with total void periods. Voids will usually be limited to a specific unit within a property. What’s more, the demand for HMOs is such that it is rarely difficult to replace tenants.

Flexibility in renting

HMOs can be used as HMOs, standard residential property or (in many cases), short-term rentals. In fact, some HMOs could, in principle at least, be all three at the same time. This gives investors a lot of flexibility in how they generate income from the property. It can also be a selling point for tenants.

For example, students might be very happy to be offered the option to rent their units just for the academic year rather than the whole calendar year. Over the summer, investors could convert the property into short-term (vacation) rentals.

This would depend on local authority rules. Many local authorities do, however, allow residential properties to be let out in their entirety for some portion of the year. This is often around 90 days/three months.

High demand

There is always high demand for rental property in the UK. The demand for HMOs is particularly high. Quite simply, they are often the default (if not only) choice for young adults. They are particularly important for those without an established social network in an area.

HMOs are also popular with people who need a place to stay for work but don’t really want to live in an area. This means that the adoption of hybrid working is likely to make them even more popular.

Cons of investing in HMOs

The reason why some investors steer clear of HMOs is that they do have very specific disadvantages. Here are the main ones.

Higher regulatory requirements

This is probably the number one downside to HMOs. They are highly regulated even by the standards of the UK property market. These regulations can be highly complex.

What’s more, in many cases it is not enough just to be in compliance with them. Landlords often have to document their compliance with them. Failure to do so can lead to heavy fines even if the property is compliant. This was an issue before the pandemic. Realistically, it’s likely to become even more of an issue as local authorities struggle to balance their books.

Increased management overheads

One of the realities of HMOs is that a person who is objectively a good tenant may not be a person that other tenants want to live with. On the one hand, to a certain extent, it’s reasonable to expect tenants to put in a certain level of effort to get along. On the other hand, if this is pushed too far, tenants will leave. They may also make it very public why they are leaving.

Landlords of HMOs also have to consider the potential impact on nearby properties. If landlords can’t resolve matters with neighbours amicably, then the council may get involved. This could potentially see the landlord forced to end the use of the property as an HMO.

This essentially means that landlords of HMOs need to think past tenant selection and onto tenant management. They also need to be able and willing to manage neighbourhood relations.

More frequent tenant turnover

One final point to note is that HMOs tend to attract tenants in some form of transition. For example, they may be new to an area and looking to learn about it before they commit. Alternatively, they may know that they only intend to stay in an area for a relatively short time. This means that HMOs tend to have more frequent tenant turnover than other types of property.

Alternatives to HMOs

It’s worth highlighting that the definition of HMO requires tenants to share facilities. It therefore does not apply to properties where tenants have their own facilities. Some investors might therefore want to look for properties that are “HMO-like” but not HMOs.

For example, investors might want to look for properties which can be easily adapted into self-contained units. From a marketing perspective, it’s preferable if each unit has a bathroom inside it. This makes the unit a self-contained studio. The bathroom can, however, be separate as long as it’s only accessible to the relevant tenant. Effectively, this means it needs to be lockable from the outside as well as from the inside.

Another option would be to look at certain areas of the commercial property market. Probably the most similar market here is purpose-built student accommodation. You could also look at care homes. All of these options deliver similar benefits to HMOs but are not regulated in the same way.