Why “Next Level HMOs” Can De-Risk Investment

There is a plethora of HMO types, from social housing and supported living to boutique and even short-stay properties.

As an HMO developer, investor and landlord for over nine years, I have been involved in a variety of different HMO offerings, and by far the one that works best for me and my associates is the ‘Next Level HMO’, a term I coined to distinguish quality properties from the remaining HMO market.

Before I go into what that comprises, let’s examine the problems in the rental market, and the opportunity within the HMO sector from a macro level.

You Might Ask: Why Even Get Involved In HMOs?

The UK residential rental market has been getting harder in which to operate, with profits shrinking dramatically, leaving little room for investors to maximise returns. In order to do deals that meet the needs of both investor and developer, there must be uplift and high monthly profit. The only strategy that reliably gives us that within a reasonable timeframe, I’ve found, is the HMO.

By renting properties by the room, you can increase profit tenfold, versus an average single buy-to-let property, reassuring investors that the strategy is sound.

There is also huge, growing demand for HMO rooms across the country. Yes, it varies by location, but from a national perspective, here are the fundamentals:

The last published count from the Office of National Statistics (ONS) indicated the mid-year 2022 population numbers should increase by 578,000 people. Given that 4.7% of the population live in HMOs (approx. 2.865 million people), that translates to a need for 27,744 more rooms per year.

The ONS also states that the number of HMOs has declined 9.5% between 2018 and 2024, from 515,904 to 476,076, an average of 6,638 HMOs lost every year. If we assume the average HMO is six bedrooms, that equates to 39,828 – so almost 40,000 rooms/accommodation units lost annually.

That’s a yearly loss of 39,828 rooms combined with an increase in demand of 27,744 rooms, so an additional 67,572 rooms needed – that’s another 11,262 6-bedroom HMOs!

As this demand naturally varies around the country, when you assess an HMO deal, it is imperative to perform your due diligence on the location and analyse the main sources of tenants.

What Exactly Is A Next Level HMO?

In general, HMOs are considered to be a safe investment bet. That said, how can we lower risk further? What type of HMO should we be creating? This is where the Next Level HMO comes into its own.

To classify an HMO development as a potential Next Level, I look for three features that indicate superior quality:

Quality space

Rooms that are of good size, where there is plenty of amenity to future-proof the property. Rules of thumb could be 10m2+ per bedroom, no more than two people sharing a bath/shower room, kitchenettes (with or without fixed cooking facilities) and a relatively large kitchen/dining/ living space. To qualify the communal space in a property as high quality, 3m2+ per person would be a minimum, with 4–5m2 being a significant bonus.

Quality design

Some thought being put into this renovation by someone who has experience in delivering design. I would want to see previous projects by the developer or their team to ensure satisfaction in the desired end result.

Quality service

A sense-check on how the property will be managed at the end, and who provides that service. A standard letting agent is likely not the right agent in this scenario. There are specialist HMO and co-living agents in most towns now, and only a handful of great ones.

When you combine these three elements, you are likely to get:

• Much better tenants, those who respect the property, who older (25 years+) with higher earning potential
• Tenants who stay much longer, because they love where they live
• The high rent that better properties command, which sustains a target % return

To protect and future-proof a Next Level HMO investment, the key factor is to have resilience in your tenant sources and a clear view of who that tenant will be: where they work, what demographic they are, and their earning potential. And you want alternative sources of tenants from different industry sectors available to facilitate multiple ways to ensure rent comes in, without fail, every month.

Next Level HMOs are also generally viewed for their turnover, so their capital value is linked to this. In most areas in the UK, this “investment” valuation will exceed the value of the bricks and mortar. This is not a bad thing, as buyers and lender will take this view as long as there have been substantial works to the property where it no longer resembles a single-family home. More beneficial and valuable is if planning permission is in place, i.e., C4 (small HMO for 3–6 tenants) planning in an Article 4 area, or sui generis (7+ tenants).

In summary, the high-quality, executive, luxury Next Level HMO, provides security as an investment and asset class, provided the fundamentals of location and tenant type are in place. Next Level HMOs are highly lucrative, bringing in higher, more resilient cashflow and more reliable profits. They are also more likely to achieve the capital value increase required to return your initial investment to you when refinancing than any other type of HMO.

If an investment is made and doesn’t go fully to plan, then time can also heal for longer-term returns – by driving the return by being actively on top of rental rates and ongoing expenses, profits will likely increase, especially as interest rates start to decline in the coming years. A great property will lock in and secure those returns.

By Matt Baker

CREDITS

Matt Baker is the Founder of The HMO Platform and CEO at Aura Ventures. He is an award-winning developer, mentor and best-selling author, and has been developing real estate since 2015 and prior to that was a professional musician.

He is the UK's leading expert on HMOs and co-living and has delivered hundreds of rooms across the UK between himself and his clients.

Matt won a lifetime achievement award at The HMO Awards 23/24 as part of the HMO Reform Group, which lobbied for and gained legal change regarding the treatment of rooms in HMOs for council tax purposes.

His mission is to increase the standard of shared accommodation nationally and raise awareness of how HMOs are not the problem, but are a crucial part of the housing solution.