Shawbrook, a challenger bank is developing a framework for HMO valuation as it sees potential growth in lending to this market going forward.
Shawbrook claims its research shows that the Houses of Multiple Occupancy (HMO) market is set to see substantial investment over the next year, with one in two property investors (53%) looking to enter or expand in the HMO market.
Current trends indicate that the demand for HMO living arrangements will continue to grow, and as the returns on HMOs are realised, investors are starting to see the potential of HMOs over traditional buy-to-lets (BTL). Nearly three quarters (72%) of investors cite yield as the main attraction for investing in a HMO followed by the potential for capital growth (29%) according to Shawbrook’s own research.
Shawbrook has identified three main category types of HMO investor:
- The Accidental Landlord: the home owner who rents out a spare room, becoming an accidental HMO as the property would have been originally purchased as a residence rather than an investment
- What it terms the “Smash and bash crowd”: active investors looking for properties that would be suitable for HMO purposes after seeing the growth opportunities, often completely reconfiguring properties to house up to six or seven tenants
- The Regular BTL: investor, who has bought a large house for a standard BTL but has used it as a HMO because the property lends itself to the model.
HMOs have traditionally been seen as low quality “bed-sit land” accommodation lived in by low income tenants. But this image is changing. HMOs are becoming a more mainstream housing option, attracting traditional and often less experienced buy-to-let investors. Research from Shawbrook has found that over a third (34%) of investors cited HMOs as their most preferred property type, an increase which has more than doubled from 16% in July 2015.
While demand is up, Shawbrook thinks few investors are aware of the key challenges they may face in the market – new regulation has increased, and investors could see threats to their current returns.
One of the most difficult issues facing lenders surrounding HMOs is how a property is valued. There is little guidance to go on in this area, with lenders approaching valuations and stress testing differently.
Karen Bennett, Sales & Marketing Director of Commercial Mortgages at Shawbrook says:
“As far as we are aware, no real valuation framework currently exists that provides the necessary clarity. This is causing problems for both lenders and investors, as the perceived value of the property affects how much equity the bank is prepared to release in order to aid them in future investments. Too much and the bank is at risk, too little and it limits the investor’s potential for expansion. A lack of guidance in this area means there is a risk that houses being approved will be questionable in their quality and this will further increase the risk to lenders.”
With a lack of a genuine valuation framework in place, work has been done by Shawbrook to try and provide at least some guidance by engaging with valuers across the country and releasing some more clearly defined categories.
- HMO1: Small HMO, no Article 4[i] or planning exists, fabric of building remains largely unchanged – lending is against value as a Private Dwelling. If the property is not in an area with an Article 4 Directive in place and the works required to convert into a HMO are minimal, it is logical that the property does not necessarily have an independent value as a HMO. An investor is more likely to purchase a cheaper property in the same street and convert this to a HMO than pay a premium price.
- HMO2: No Article 4 or planning exists but there is a demand for this property as a HMO, the fabric of the building has changed – lending is against Market Value. Where the property is not in an area with an Article 4 Directive in place. If specialist/ extensive works are required to convert into a HMO and the security is in an area that supports HMO demand, it is logical that the property will have an independent value as a HMO. As such, any investor is likely to recognise the need to pay a premium.
- HMO3: Article 4 is in place – lending is against Market Value – If the property is in an area that has an Article 4 Directive in place, it is in an area where a HMO is clearly a viable investment and will have an independent value as a HMO. As such, any investor wishing to run a HMO in the area understands there is likely to be a premium price to the value.
- HMO4: Sui Generis planning is in place – lending is against Market Value – Planning is in place to use as a large HMO (7 beds +), and will have very specific structural changes to be utilised as a HMO.
Stephen Johnson, Deputy CEO and Managing Director for Commercial Mortgages at Shawbrook adds:
“As the spotlight continues to shine on the HMO space, it is becoming increasingly important for investors to have a good grasp of these more technical concerns and an understanding of future risks.
“While there are certainly new challenges on the horizon, there are still a great number of opportunities in this market that has produced excellent yields for property investors in the past. Taking a responsible approach means that a sustainable future for the market can certainly be found. This is a market that is constantly moving and investors and lenders will need to learn, adapt, and move with the times if they are to continue to take advantage of the opportunities presented by this attractive asset class.”
Download the latest Shawbrook Bank HMO Report
[i] Use Class of ‘C4’ or House in Multiple Occupation requires landlords to gain planning permission before they can let what was formerly used as a family house (C3) as a small HMO (C4) housing between three and six unrelated sharers. This is known as a ‘Change in Use’. Where an Article 4 Direction is in effect, a local authority may not demand a fee for associated planning applications. In October 2010 the Coalition Government amended the legislation. To do this, they included a ‘Change in Use’ from C3 to C4 within the General Permitted Development Order (GPDO). This allowed landlords to change their properties from a C3 Dwelling House to a C4 HMO without the need for planning permission. However, they also gave local authorities the power to remove permission for the C3 – C4 ‘Change in Use’ by means of an ‘Article 4 Direction’. Councils have used this to designate whole areas and limit the number of HMO’s in a geographical area.
Shawbrook Bank looks to HMO investment growth https://t.co/588MvDIFl9
— LandlordZONE (@LandlordZONE) May 3, 2016