When it comes to HMOs, there is a lot of misinformation out there. One of those areas I’m going to try and address here is mortgages and how HMOs are valued, particularly when it comes to ‘commercial’ valuations.
Let me start by saying I’m not going to tell you what you’re probably hoping to hear. You’re not going to buy a 2 bed terraced house for £100,000, spend £20,000 converting it into a 16 bedroom HMO, then get a bank to value it at £300,000 take all your money out of it. It’s simply not going to happen!
On the other hand, commercial valuations aren’t as elusive as some brokers would have you believe. Let’s take a look at a few different real life scenarios to demonstrate what’s possible and what factors will be considered in determining the valuation.
Bricks & Mortar Valuations
I don’t know the exact statistics of how many HMOs will qualify for commercial valuations, but let’s just say that 90% of HMO projects should be entered into with the assumption that the end product will be valued based on bricks and mortar and comparable properties in the area.
Even if you think your project might be valued as a commercial entity, isn’t it better to plan for the worst case valuation and anything over and above that is a bonus?
To understand how bricks and mortar valuations are reached, I’ve spoken to umpteen surveyors to see how they work, and 9 times out of 10 they rely on the same criteria – what comparable properties have sold for in the area.
If you want to get a little more detailed on this, the ideal comparable for a valuation survey looks like this:
- Same size property (overall square metres)
- Number of bedrooms/bathrooms/reception rooms
- Same style of property (detached, semi-detached, terraced etc)
- Within 1/4 mile of your house
- Same condition (newly renovated)
- Same amenities (garage, parking, garden size etc)
- Sold within the last year
This poses enough problems when you’re looking at a simple residential purchase, as the surveyor won’t just want one comparable, but ideally 3.
If property in your area doesn’t sell very often then the most recent data could be years out of date and result in lower value comparison.
Similarly if you’ve spent a lot of money on things like adding en-suites, converting the loft, and extending the kitchen, there might not be any houses in your area that have been renovated to the same standard to compare against.
In these cases the surveyor may expand his search to look within 1/2 a mile, or at properties that sold between 1 and 2 years ago, but the point is this method is pretty simple to understand so you should be able to come up with a pretty accurate end valuation before you even make an offer on the property.
It’s easy to make mistakes though, particularly when we think our investment is worth more than anything else in the area.
If you’ve turned a 2 bedroom terraced house into a 5 bedroom HMO, you may be tempted to use the 5 bedroom detached family home down the road as the nearest comparable property, but it’s unlikely the surveyor will have the same opinion.
Going back to the list above, the number of bedrooms is only 1 factor, and if that’s the only factor two properties have in common, the surveyor will likely dismiss it as a comparison.
Obviously finding three other 5 bedroom terraced houses could be a challenge though, so the end valuation will be determined be weighting each of the factors and you’ll likely end up with a valuation based on the largest terraced houses available (perhaps 3 or 4 bedrooms), with an addition based on local price per square foot, average cost per bedroom, or some other subjective factor.
Given that there is absolutely an element of subjectivity to the valuation, it is worth showing up prepared to the valuation and making a case for the valuation you’re hoping for. Keeping in mind of course that training to be a surveyor takes time, and if you start being too pushy and telling them how to do their job, you might have a worse effect than saying nothing.
When doing your end valuations during a project appraisal, basing it on bricks and mortar is the safest approach, and having a range when comparable properties are uncommon gives you an extra level of protection.
Commercial valuations are talked about with revery in property circles as the pinnacle of HMO success.
The main reason for this is that typically a commercial valuation will be higher than a bricks and mortar valuation and as such you’ll have the ability to release more of your initial investment capital following a refinance, and/or have a lower loan to value ratio which could result in better interest rates.
The reality is that whilst this is fantastic when it happens, getting a commercial valuation on something that looks, feels and smells like a house is pretty damn tough.
There are a couple of rules of thumb I’ve heard from brokers and surveyors on the subject of commercial valuations:
- If you’ve bought a house and converted it by adding fire doors and en-suites, it’s still a house and will get valued as such
- If you could buy another house on the street and convert it to an HMO without major issue, it’s still a house and will get valued as such
In a nutshell then, if it’s a house that you happen to rent to multiple people on a room by room basis, it’s still a house and will get valued as such.
I feel like I’m starting to repeat myself… but it’s an important point to take on board now rather than when you’re desperate for a commercial valuation to repay an investor or bridging finance.
So what will actually qualify for a commercial valuation?
There are no hard and fast rules, and again it can be subjective based on the lender’s criteria, the location, what side of bed the surveyor got out of, and a whole host of other variables.
But applying a bit of logic and working backwards from what won’t qualify for a commercial valuation, we can make a few educated observations.
If you’ve bought a commercial property (e.g. an office or retail space), taken it through the planning process, and converted it to a purpose built house of multiple occupancy, then you’re starting with a much more solid argument for a commercial valuation.
Whilst finding comparable properties for your 5 bedroom terraced HMO might be a little awkward, finding a comparable for a 12 bedroom HMO on the high street of your local town will be virtually impossible, hence using other criteria such as rental income multipliers to assist.
Think of it like this, if you moved all the tenants out, could it be put on the market with a high street estate agent and sold as a family home with little or no changes required? If the answer is no, then you might be able to justify a commercial valuation.
How are commercial valuations calculated?
Another critical part of the valuation debate is how much will you actually get if you do qualify for a commercial value.
We have been told the typical rental multiplier can range from 8 – 12 times annual rent, with the lower multiplier being applied in lower value areas where the demand for HMOs might be uncertain, up to the higher end for properties in London zone 1.
Based on this, we assumed our latest 9 bedroom HMO would achieve 8 or 9 times. Not because it’s low quality or in a bad area, but Stockport isn’t a big city, it’s certainly not London, and going back to my earlier point, we had planned for the worst case.
In reality we ended up with a 10 times multiplier which we were absolutely delighted with, based on £5,000 per month rental income.
That’s not the end of the story though! The multiplier is only the first part of the equation. You also need to factor in an allowance for running costs which the lender will deduct before reaching their final valuation.
You won’t be surprised to hear that there is a range here again, with rumours of 25%-40% of gross rental income being deducted. In our case we were fortunate again, with a 25% deduction being made, so our end value for the property was £450,000
The equation looks something like this:
Annual Rental Income x Rental Multiplier – Running Cost Allowance = Commercial Valuation
or in our case:
£60,000 x 10 – 25% = £450,000
The worst case with an 8 times multiplier and a 40% allowance would have been a completely different story at £360,000, so it makes sense to consult a broker familiar with your area and your proposed lender to get an idea of their criteria.
Other Ways to Maximise Your Refinance
If the commercial valuation isn’t an option for you, all hope isn’t lost for recovering most of your investment.
One option is to go to a lender who offers higher loan to value ratios, like Kent Reliance who will go up to 85% on HMO mortgages.
That extra 10% could be a chunk of money that allows you to move on to the next project, which, depending on your circumstances, could be worth the higher interest rate and monthly payments.
The other option is to speak to your broker to find a lender who will to a hybrid valuation based on bricks and mortar but taking rental income into consideration.
The appetite for lenders towards HMOs changes like the weather, so available products will vary depending on when you’re applying, but some of the more specialist HMO products will put a small premium on the value if you’re showing significantly higher rental income than a standard buy to let in the same area.
How they calculate this premium is a mystery even to me, but to give a real life example we had a terraced house that we converted into a 6 bedroom HMO. It’s very much a residential property but generates over £3,000 per month in rental income.
On the open market it’d probably sell for around £150,000 to a residential buyer, but our lender valued it at £180,000. Now this is almost £100,000 less than a true commercial valuation, but still allowed us to release an additional £22,500 compared to what we could have done with a £150,000 valuation.
Disclaimer: I am in no way qualified to give financial advice. Like I say above, this is anecdotal evidence from my own experiences. If you’re looking for mortgage advice, speak to a specialist investment mortgage broker like Harvey Bowes. Tell them I sent you!