“My HMO will be the best in town…”
👀 Seeing what you want to see 👀
I usually assist at least 1 person a day with their GDV appraisals for their HMO developments.
Most of these 5-7 people a week are asking for my advice because they are new to either HMOs or the area and they are seeking assurances over end values on a product that doesn’t usually have an obvious comparable.
In other words, they are looking to create a new beautiful HMO in an area that’s not renowned for ‘boutique HMOs’ and therefore end values can be a bit ambiguous.
It’s not to say that HMOs there won’t work but the primary attraction is cheap housing stock, ease of planning and the notion of a BRR.
To be fair, most of these people usually have their ‘gross yield multiplier’ roughly spot on.
The most common bracket for the areas we’re talking about is 11-14% gross yield and we can discuss quite easily and proactively where their property would fit on this scale depending on the other USPs.
The biggest issue usually is that the wannabe developer is too optimistic over their room rates and that’s what skews things.
I can tell that they are seeing only what they want to see on Spareroom.
There might be 25 adverts for rooms between £450-£550 a month and then 1 at £625 so this automatically means that the new 8-bed HMO we’re now discussing will have 10 en-suite rooms listed with an ERV of £650 PCM.
“My HMO will be the best in the town so I’ll smash the rental ceiling” – I heard this quote 4 times in one day relating to Scunthorpe once.
It’s not to say that £650 per room isn’t achievable, or that it won’t be secured in reality (in the early days of the brand new development, usually), but it comes with risks when the whole deal hangs on hitting a rental ceiling constantly.
The total rental income would be £78,000 in this example.
One of 3 things will happens;
1. The property won’t hit that level across the 10 rooms at all and will settle around £70,000 PA
2. The property will fill initially at £78,000 (often with tenant incentives built in to kid the valuer 🤫) but then the rates will settle down to where it’s true value is or have higher voids/churn
3. The property will hit the high room rates consistently but need one hell of an effort (and maintenance pot) to keep up with the Jones’s nearby and to keep the product at the top of the market.
In all 3 cases the bottom line is affected, either by a decrease in rent from expectation or an increase in costs/voids.
What this does mean in terms of value?
£78,000PA @ 12% yield is £650,000. Let’s assume that this is the target refinance level for the wannabe developer.
The other HMOs locally that have been sold or financed at 12% gross yield are much cheaper because they have an average room rate of £475 – £525 PCM or a ‘room value’ of £47,500 – £52,500.
The HMO with a hopeful GDV of £650,000 is expecting a room value of £65,000 which could be too high for a lender to stomach.
Even if they are wooed by the product and give the £650,000 value, the expectation is that the rental income will regress over the next 5 years or the extra operational costs will end up being a noose for the owner.
At £70,000 PA, the property would be worth £585,000 @ 12%.
Or, at £78,000 but with a 1% added on to cover for the extra voids/costs, the property would be worth £600,000 (13%).
It would be sensible to base a refinance around this level rather than the £650,000 but I understand that the ‘extra’ £50-65k is the BRR money…
What advice do I give in these situations?
I always ask the developer to check in with local landlords who manage HMOs in the area and to chat directly with good managing agents who have operated a similar product for a few full tenant cycles. They’ll tell you if £650 PCM is sustainable.
If it is, then bloody crack on! Get the £650,000 because the HMO is worth it.
But if you have a seed of doubt over the ability to keep 10 rooms full over 95% of the time at £650 PCM then don’t see what you want to see on SpareRoom just to force your numbers to stack.
Over-valuing comes most often in these cases not from the developer basing their numbers off a leaner yield but by the developer being too toppy with their income.
If you know you’re doing it just to get that initial refinance in, but you have factored in a settling down of rents into your model and you have the means to cover any future lower re-valuations, then that’s not an issue for me. That’s your choice.
If you are basing everything, as someone a) new to HMOs, b) new to the area (which is a secondary HMO spot, usually) and c) who is looking to rinse as much capital out because you are using Angel investment, I would really recommend that you nail down on your rental figures really hard and confirm that they will stack not just initially but in years 2, 3 and 4…
