Hi it’s Dr Ro here! Answering your questions on property.
And a great question has come in relating to:
Should I be investing in HMOs?
Now this is a subject I think that is worthy of a little bit more attention, and I’m actually going to come back and revisit this on a couple of occasions in this blog.
I have three questions for you, to help you answer ‘Should I be investing in HMOs?’
1. Do you own any Buy to Let Properties?
If you’re brand new to property and you don’t own any other properties at the moment, it’s probably worth you starting with a small Buy to Let.
It is what we call the bottom of the income pyramid. If you start with a Buy To Let portfolio, even if it’s two or three properties, this will give you more confidence. It will also improve your ability to borrow from banks,to build your HMO portfolio.
So, that’s a consideration and again, go and seek professional advice on this.
2. Are you looking for more passive income?
If you are, building an HMO portfolio is definitely a good strategy. For every single unit you buy that could be a Buy To Let, it potentially has the ability to be turned into an HMO. You can do this to your Buy to Let if it has say, three or four rooms that are lettable.
This isn’t going to work if you’re doing a flat or an apartment, but it would work if it was a three-bedroom house with one reception room. So, are you looking for more passive income?
And of course the third question is:
3. If you are looking for more passive income, are you happy to invest in other areas where HMOs work, apart from where you live or already invest?
You might have two, or three, or four Buy To Let properties already. They’re going pretty well. But you might find actually that in this particular area, you’re looking to buy and expand the portfolio of HMO properties, and it just doesn’t work for HMO.
For example, it might be that this is a brilliant family area, but most single people don’t want to rent there. Or it might be that it’s a brilliant family area and you want to rent to students, but there’s no student university nearby, or if it’s too far from the university. Or it might be that you’re looking at houses and you’re thinking these are great to do as HMOs, but actually they’re just too far from the railway station, there is no public transport, it’s not ideally suited. So, some areas are not right for HMOs. It might even be there’s an article four area, where there’s restrictions on whether you can even do that.
What if You’ve Bought a Buy to Let Property, and You Want to Turn it Into an HMO
Let’s consider an example situation. You’ve bought yourself a Buy To Let property. You have a tenant, John, and he’s going to move into your Buy To Let property. He’s got an AST, an assured short hold tenancy, agreement with you. And he’s going to pay you £600 a month for the privilege to rent your property from you. This is a family house. He hasn’t got any family, but he is renting it. In other words he has got maybe three rooms, one reception room downstairs. He is looking to have a family in the future maybe, but right now he is having to rent the property from you.
When we do our calculations, we basically take the rent we minus the costs. Costs include things like management, operating costs. From that subtraction, we get the net cash flow. Now as a simple rule of thumb for UK properties, particularly when you’re buying properties in the North, with interest rates we’ve currently got at the moment: If you divide the gross rent by two, that gives you approximately the monthly cashflow. In this case, £300 a month.
Let us now consider an alternative situation to John living there. Instead, you decide to rent it out as an HMO. You’ve bought the house, you’ve bought it for the same price, you’ve put the same deposit money down. You’ve now put a little bit more into doing up the rooms. And after that work, you can put four people in there.
Now we have John, Mary, Sarah and Michael all moving into your house. And they are happy to pay you £450 a month each, times four rooms, which gives you a total of £1800 per month of gross rent coming in. When it comes to costs, they are going to be higher. This is because you’re paying the mortgage, as well as the gas, electric, council tax and all the running costs. So you take the rent, minus the cost that generates you a cash flow and, in this example, I’m giving you a figure of approximately £850 per month cash flow, which is reasonably accurate. Normally you divide by two, but it depends on the type of mortgage you’ve got and the interest rates. But if you assume a monthly income from rent of £1800 per month, you’re getting about £850 cash flow on an HMO.
Look at the difference here. We’ve got £850 a month versus £300 a month. We’ve got one tenant in the Buy To Let example, we’ve got four tenants in the HMO example. Now I’m using this as a room let example, of course, you can scale up to another level of HMO, which is a fully qualified HMO, which means you might get have six, seven, eight, or nine bedrooms. You’ve got licensing to consider, you’ve got planning permission to consider.
If you want a natural progression up to the easiest form of HMO, in other words a small HMO, or a room let model, you’re looking at four tenants. I wanted to keep it simple for now, just to show you the difference between the two. You’ve got £300 versus £850, it’s almost three times as much cash flow. That’s why we love this model.
Building an HMO Portfolio
I want you to imagine a situation where you’ve got the ability, you’ve earned enough money, you’ve saved enough money, you might have been able to borrow money from family members for example, to help you build this portfolio.
You now have the ability to not just buy one property, but you can buy several properties. As a Buy To Let it will produce £300 a month for you. As an HMO, it will produce £850 a month for you. So, imagine a situation where you can split your money and now you can start to buy one, two, three in this case four properties. You could do four Buy To Let properties which would produce for you £1200 per month net cash flow. Or you could buy the four properties, and this time instead of operating them as Buy To Lets, operate them as HMOs.
Yes, there will be an additional cost because you’ve got to put some more work into converting into a small HMO. But the difference there is you’re producing for yourself £3400 a month, net cash flow on all four properties. This is a significant difference. What we are talking about here is building a portfolio, we are talking about generating higher cash flow.
It might be that your financial freedom figure is actually £3400 a month. It might be that your financial freedom figure is £6000 a month, in which case you’re at least just over halfway. It might be you decide you want to start with four Buy To Let properties and produce £1200 a month, and now with a bit more experience you decide to scale up and put another four in place, and now you get £3400 a month. And now you’re up to £4600 a month and then you might say, well hold on a minute, those first four properties that I had as Buy To Lets, why don’t I now switch them over to small HMOs, and now I’ve got £3400 on the first four, £3400 on the second four, giving me £6800 a month cash flow. Which actually exceeds what I need, and hey presto, I’m financially free.
Now, let’s just jump back to the beginning.
Okay, so the three questions:
- Do you own any Buy To Lets already? I do Dr Ro.
- Are you looking for more passive income? I am Dr Ro.
- And are you happy to invest in other areas where HMOs work better? I am.
Your Buy To Lets that you currently own might actually be in a good location for HMOs, in which case you say, “hey, you know what? I want to increase my income, should I invest HMOs? From what I can see here, if I want more income. Yes, in that case, let me turn my existing Buy To Lets into HMOs.” Or it could be you keep your Buy To Lets as they are, and you go find another area where HMOs work better. From there, you start to increase your passive income.
I’ll tackle this subject in other questions as we start to look into this deeper. But for now I hope this has answered the question, should I invest in HMOs?
And I think these questions will help guide you.
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