Houses of multiple occupation (HMOs) have become increasingly popular with property investors in recent years and as property owners look for ways to increase their yield to counteract the introduction of mortgage interest relief restrictions, their popularity is likely to increase even further.
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The HMO market is thriving
In March Shawbrook Bank predicted HMOs would be the most popular property type among investors this year, with over a third of respondents to its Client Barometer report stating HMOs were their preferred property type.
HMOs are favoured largely by investors who prioritise income over capital growth — by renting out four rooms in a house individually it’s possible to charge a lot more than by renting out the same house on a single assured shorthold tenancy to one family.
According to research by Platinum Property Partners last year, HMOs rented to professionals outperformed all other assets classes during the period 2010-2014. Its research put the average gross yield of a HMO at 12.4%, substantially higher than the 5% achieved by standard buy-to-lets.
However, Platinum also noted that the initial investment required for HMOs was higher than for standard buy-to-lets. Partially, this is due to the substantially higher refurbishment costs required to turn a single occupancy property into a HMO, with adaptations such as additional bathrooms and kitchens much more costly than the tidy-up that’s often the only thing required of a newly-purchased single let. There are ways to offset these costs though by claiming capital allowances rather than standard tax relief on this kind of work, which we’ve covered in detail before.
Refurbishment costs aren’t the only difference between standard buy-to-lets and HMOs, however, and as we outlined in another previous article, there are many more ongoing costs and demands on your time with HMOs.
Since that article was written, however, there have also been a number of legal and tax changes that are affecting the HMO market, so we thought we’d put together an extra checklist of things you should consider before either buying a property with the intention of turning it into a HMO, or converting an existing property into a HMO.
Abolishment of wear & tear
Although the government’s decision to get rid of the wear and tear allowance has generally been viewed as a negative for furnished buy-to-let owners, for HMO owners the change may, over time, not be as detrimental. Although you’ll no longer be entitled to the automatic 10% deduction whether you incur costs or not, because HMOs have a higher tenant turnover and there are more people sharing facilities, replacements may be needed more frequently so being able to deduct the entire cost of these may end up being more favourable to HMO investors.
If you’re buying a new property, you may benefit from striking a deal with the seller to purchase the existing furnishings — that way when you replace them you’ll be able to offset the cost in full, as opposed to if you’d been buying furnishings for the first time. See our previous article for greater detail on this strategy.
Council tax revaluation for HMOs
One unwelcome development in the HMO market has been the trend for the Valuation Office Agency (VOA) to reband HMOs so that each room is considered a dwelling for council tax purposes. There are rules about when the VOA can determine a house has become multiple dwellings, but it’s safe to say many, if not most, HMOs could be liable for council tax increases of some kind. If your HMO is hit by a rebanding your council tax costs could easily triple or quadruple, which will seriously impact your yield.
Anecdotal evidence suggests more and more cash-strapped councils are pursuing this strategy to boost revenues — they are often tipped off by planning applications so always make sure you avoid making any planning applications unless they are strictly necessary. We’re not suggesting doing work without the necessary permission, but many extensions to houses can be done under permitted development and do not require permission.
Changing the use of a property from a single dwelling to a small HMO falls under permitted development and does not require planning permission, however, you will need planning permission if there is an Article 4 direction relating to HMOs in your area, which brings us to our next point…
HMOs and Article 4 directions, licensing
Another unwelcome trend is that local councils around the country are increasingly bringing in Article 4 directions related to HMOs. The general rule across England is that you only need a HMO licence if you have a ‘large HMO’, defined as one which is on three or more storeys and has five or more persons forming two or more households.
However, councils have the power to bring in additional HMO licensing if they consider there are too many HMOs in an area or there are problems related to HMOs, and more councils are doing this around the country. If an Article 4 direction is in place, you will need planning permission to change the use to a small HMO and if an area already has a certain percentage of properties in HMO use, the council will likely refuse permission.
Even in areas where Article 4 directions are in place, estate agents frequently advertise properties for sale as suitable for student lets/sharers even when the properties in question do not have permission for use as a HMO and in some cases, no realistic prospect of getting it. Therefore, your first line of enquiry when considering any property should be the local council — find out if an Article 4 direction on HMOs is in place, and if so, if new applications are being considered.
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Fines became unlimited
There are many regulations that HMO owners must adhere to and there have long been fines for those that fail to do so, for example, by failing to apply for a licence if one is required or not meeting minimum fire safety standards.
However, last year a change to the Legal Aid, Sentencing and Punishment of Offenders Act 2012 removed the £5,000 cap on magistrates fines to an unlimited amount, meaning magistrates can impose fines at their discretion. This, according to Anthony Gold Solicitors, will lead to radical increases in fines for HMO landlords who get things wrong.
Although HMOs are undoubtedly higher yielding investments than standard buy-to-lets, as you can see, rigorous due diligence is needed when assessing the viability of converting a property into a HMO or buying an existing HMO.
The final word on capital allowances on HMOs
Expenditure on altering or improving dwelling houses has never qualified for capital allowances, however, landlords of furnished buy-to-let properties were previously able to compensate for this to some extent by claiming the 10% wear and tear allowance.
The reason that HMOs and flats qualify for capital allowances whereas single occupancy homes do not lies in HMRC’s interpretation of what constitutes a dwelling house. Whilst individual rooms or flats are treated as separate dwelling houses, HMRC accepts that communal parts are not. As capital allowances are only prohibited on dwelling houses, this means that claims can potentially be made on plant and machinery included in the communal areas.
Due to this interpretation, savvy landlords were quick to identify the opportunity to claim allowances on kitchens and bathrooms where these were made into shared rooms within a house. Unfortunately, this opportunity has now been closed as HMRC has clarified its view that where individual rooms do not provide residents with the facilities required for everyday private domestic existence, then the shared facilities including kitchens, bathrooms and living rooms will still fall within the definition of a dwelling house.
Whilst HMRC’s interpretation now precludes a lot of expenditure from qualifying for capital allowances, there is still scope to claim for items such as plumbing systems, electrical systems, lighting and lifts in communal areas such corridors, hallways and basements etc.
A recent court case TC07383 HORA TEVFIK shows how the courts have mixed views about what makes up an HMO and what capital allowances may be claimed. There are still areas that have not been clarified about shared areas. Michael Connell a tribunal Judge focused on the HMRC’s brief “HMRC’s Brief 45/10 replaced 66/08 in order to remove the uncertainty around the definition of ‘dwelling-house’. We concur with HMRC’s updated view that the definition of a dwelling-house in s531 Part 10 CAA was specific to that Part only. For other Parts of CAA2001,‘dwelling-house’ should take its everyday meaning. A definition based on the presence of the facilities required for day-to-day private domestic existence is a better everyday description. Each flat in multiple occupation comprises a dwelling-house. The individual bedrooms alone would not afford the occupants ‘the facilities required for day to day private existence’(Gravesham). A communal kitchen and lounge are also part of a dwelling-house”
This is also supported the CAA 2001, s35 Exclusions of capital allowances where it states that “Expenditure on plant or machinery for use in dwelling-house not qualifying expenditure in certain cases”
In our opinion it is not worth claiming capital allowances on HMO’s.
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