Landlords still investing heavily in HMOs despite regulatory challenges

A new report from Paragon Bank reveals that experienced HMO (Houses in Multiple Occupation) landlords are continuing to invest in these types of rentals, making property improvements that cost thousands, 

According to Paragon, 28 per cent of these landlords are expecting to spend over £10,000 in the coming year, that’s despite the increasing red tape introduced by the Renters’ Rights Act and tax restrictions making small-scale landlords take stock and stall investment plans or decide to leave the sector.

Portfolio landlords

These HMO landlords operate with a different mindset to the traditional small-scale buy-to-let landlord with just one or two properties. Or certainly under the four properties limit generally accepted as the difference between an amateur and a professional landlord, who often use the tax advantages of operating as a limited company.

The Paragon Bank survey shows that around 28 per cent of HMO landlords have plans to spend over £10,000 on upgrades over the next 12 months, while 15 per cent expect to invest between £5,000 and £10,000.

Sixty-two per cent were found to have improved an HMO property over the last six months, while 24 per cent did so within the previous year. These landlords are showing a commitment to building a portfolio with 80 per cent saying they intend to either increase or maintain their property portfolios over the coming year. 

By far the majority of the respondents – three-quarters – had been in the business for at least 10 years, so they were well experienced on the HMO scene and were confident enough of the long-term prospects to invest more.  

More data from Paragon Bank shows that HMOs generate on average a rental yield of almost 9 per cent, roughly double the average for single lets and remaining the highest-performing property type in the UK.  

The upgrades being tackled range from general presentation (kitchens, bathrooms, decoration) to the necessary changes needed to improve EPC ratings to comply with more stringent targets by 2030, insulation, boilers, and safety-related issues, including fire doors and fire and gas safety alarms. 

The controversy surrounding HMOs

Sometimes HMO investors have to run the gauntlet of controversies surrounding these types of properties because they sit at the crossroads of a severe UK housing shortage and community resistance.

While HMO investors have come to appreciate their potential for generating high rental yields, two to three times higher than standard buy-to-lets, local communities and councils increasingly view HMOs as a blight on some communities These are often seen as an imposition that destroys street environments and family housing stock. The stresses and strains on local infrastructure can lower neighbourhood living standards.

The investor vs. community conflict

A primary source of friction with HMOs in English towns and cities is the removal of family homes from the market and replacing them with a scene where some streets become dominated by HMOs. This can radically change local schools, shops, and community dynamics.

To reduce the harm, an increasing number of local authorities are implementing Article 4 Directives. This removes the otherwise available permitted development rights, meaning investors must apply for and achieve full planning permission to convert a standard class C3 dwelling (a normal house) into even a small C4 HMO with 3 to 6 occupants. 

In many HMO hot spots, councils flatly refuse new HMO applications if the density of shared housing on a street exceeds a certain threshold, generally set at 10 per cent.

Traditionally HMOs have been associated with rogue landlords, tenant exploitation, cheap bed-sits and even beds in shed spaces. The HMO sector has faced intense scrutiny over living standards affecting local amenities. 

While many HMO landlords are now providing much high-end co-living spaces, because of the increased demand for such accommodation, rogue landlords frequently make headlines for overcrowding, subdivided properties breaking minimum space requirements, creating unsafe and hazardous conditions by violating fire safety regulations, dampness, poor insulation, and licensing evasion.

Councils also frequently complain about waste management issues, iIncluding overflowing bins and fly-tipping, causing more friction between transient HMO tenants and permanent residents.

Regulatory headwinds for investors

As a new investor, because of all the above and an increasingly challenging regulatory environment, before deciding to allocate capital to an English HMO, take stock of what you are up against vs the benefits of higher yields. 

Mandatory licensing is necessary for any HMOs with 5 or more occupants from two or more separate households. In addition, some locations require selective/additional licensing. Many councils invoke local powers requiring all landlords or all HMOs, regardless of their size, to be licensed and inspected.

There are regulations governing minimum room sizes; strict statutory minimum bedroom sizes apply. For example, there’s a 6.51 m² minimum for a single adult, and councils can set even higher local limits.

With the abolition of Section 24 tax relief, higher stamp duty land tax (SDLT) surcharges for additional properties, and stricter EPC (Energy Performance Certificates) requirements, profits came down. 

A different business model

To mitigate controversy and safeguard against regulatory pressures, a new class of HMO investor has moved away from cheap, high-density conversions towards a more sustainable model.

They focus on high-end co-living spaces for corporate young professionals or specialised healthcare and education-related staff. These generally receive fewer neighbourhood complaints.

These HMO units are usually operated through limited companies to improve tax efficiency and are professionally managed, handling tenant vetting, waste management, and property maintenance to a high standard.

New entrants

If you are considering entering this mode of operation, you should be evaluating towns and cities, specific regions or property types for a potential HMO investment.

Remember that HMOs require more time and commitment, they are more difficult to manage than are standard lets. The majority of serious HMO landlords are full-time rather than part-time landlords.

Due diligence is necessary for Article 4 requirements. Never buy a property assuming you can convert it without checking first with the local council's specific spatial policy maps and their planning offices.

Your target tenant demographic, such as students, young professionals, or social housing, will determine the type of property and location and whether you should be looking for small (under 5 beds) or large HMO formats.

Paragon Bank’s response

Managing Director of Mortgages at Paragon Bank, Louisa Sedgwick, talking about their research findings, has said:

“These findings show that many HMO home providers are experienced operators who continue to take a long-term view of the sector. HMOs can be more complex to manage than standard buy-to-let properties, but they remain attractive to landlords who understand the market and have the expertise to operate successfully within it.

“What stands out is that landlords are continuing to invest as standards, costs and regulation evolve. The level of planned expenditure suggests that many are focused on maintaining quality, supporting compliance and ensuring their properties remain well positioned over the long term.

“For brokers, this creates opportunities to support landlords who are reviewing their portfolios, funding improvement works or looking to structure borrowing around more specialist property types. Understanding the reasons behind that investment, whether linked to asset quality, regulatory requirements or long-term returns, is increasingly important when advising clients in the HMO market.”

Paragon lends to private individuals and limited companies and provides mortgages suitable for single, self-contained properties, as well as HMOs and multi-unit blocks. 

[Main image credit: AXP Photography]