HMO Valuations: Commercial vs Brick-and-mortar
Houses in Multiple Occupation (HMOs) represent a unique segment in the real estate market, having become an increasingly popular investment choice that often attract investors due to their potential for higher rental yields compared to standard buy-to-let properties. Accurately valuing a HMO, however, can be a complex process that is usually approached in two primary ways: commercial investment valuations or traditional brick-and-mortar valuations. While both offer pathways to understanding an HMO’s worth, they focus on different aspects and are best suited for different situations.
Commercial Investment Valuations
The commercial investment valuation method, often preferred by experienced HMO investors and lenders specializing in this asset class, places primary emphasis on the income-generating capacity of the property. It treats the HMO as a small business, analysing its profitability and comparing it to similar income-producing assets in the market. This approach is based on the principle that the value of an investment property is directly related to the income it generates. As you will see, the commercial HMO valuation method is more complex than the brick-and-mortar methodology, but this isn’t to say there is an agreed upon method, and opinions often differ when it comes to calculating the value of a commercial HMO. However, one possible method of calculation would be as follows:
(Gross Monthly Rent – Reasonable Operating Costs) * 12 / Yield
Or
Annual Net Rent / Yield
For instance, if the property was a 5-bedroom HMO with a 6% yield, the calculation would be as follows:
(£3000 – £600) * 12 / 6% = £480,000
Such a method allows investors to view their commercial HMO’s potential returns in relation to empirical data, as opposed to the relative valuation method of brick-and-mortar HMOs.
Some key factors of commercial investment valuation are:
- This method directly considers the income-generating capacity of HMOs compared to single-family rentals
- Highlights the property’s ability to service debt
- Understanding the property’s income-generating potential allows for better investment and management decisions
Residential Brick-and-Mortar
In contrast to the income-focused approach of commercial HMOs, the brick-and-mortar valuation method, sometimes referred to as comparative market analysis (CMA), primarily considers the property’s physical structure (size and condition), the location, and the value of comparable properties in the immediate vicinity. This method treats the HMO as a residential property, comparing it to other similar properties based on their sale prices, therein focusing on the intrinsic value of the property itself, rather than solely its income-generating capacity. Key factors of a brick-and-mortar valuation are:
- This method can be useful for investors new to HMOs, providing a familiar benchmark for property valuation
- For properties with limited historical income data or those requiring significant renovation to realize their full HMO potential, a brick-and-mortar valuation can be a good starting point
- Lenders offering standard residential mortgages may rely on this method as they primarily assess the property’s intrinsic value
- This method can help narrow down potential investment properties by focusing on desirable locations and property characteristics
Confusion
As one can see, the process of HMO valuation is not straightforward, and in addition to the two methodologies mentioned, there are three further factors that may cause confusion during the process, namely: Whether the property holds a license, planning use, and the specific guidelines set by each respective lender.
Regarding licenses and planning use, typically a standard house falls under C3 planning use. Landlords can apply for a small HMO license for three to six occupants under permitted development rights. However, if the local council has implemented an Article 4 direction in that area, landlords must obtain permission from the council to convert to C4 use.
Following this, each respective lender—as per all the prior complexities—is going to have their own specific set of guidelines, and though it may be that case that these guidelines often overlap or appear similar, the client and broker must always ensure to work as closely as possible with the lender as to really get to grips with the valuation requirements in place.
As such, the importance when it comes to valuation regarding the two different methodologies—inclusive of planning and license details—is how the lender is going to instruct the surveyor, with the most appropriate valuation method dependent on the specific circumstances and the purpose of the valuation.
Considerations
While brick-and-mortar valuations offer a starting point based on comparable sales, commercial investment valuations are generally more accurate and relevant for established investors, especially when assessing investment potential and securing specialist financing.
Likewise, experienced HMO investors will find the Commercial Investment Valuation method indispensable for making informed decisions. However, a combined approach, where both methods are considered, can provide a comprehensive understanding of an HMO’s value, allowing for a more nuanced assessment of its potential.
By understanding the nuances of both methods, investors can make more informed decisions, maximize their returns, and navigate the complex world of HMO investment with confidence.
What we can do for you
Here at Word On The Street, we always like to emphasize the importance of making sure our clients ask the right questions with the lenders you’re considering in relation to the valuation type. Equally, when you do get an answer, always be sure to listen and act on that advice.
If you are interested in finding out more about which valuation method is right for you, or discussing an investment requirement contact the team today.
