Houses in Multiple Occupation (HMOs) are the most stable and profitable form of buy to let investment in the UK, protecting landlords against higher costs caused by an interest rate rise, a new analysis report suggests.
HMOs, generally rented to young professionals and key workers, are intrinsically geared towards maximising rental income by letting each room on an individual basis, according to the report from Platinum Property Partners (PPP).
Research for PPP has shown that compared to capital gains, rental income for all types of BTL is by far the most dependable and stable source of return on investment. The firm says that HMOs landlords are therefore best positioned to absorb the higher mortgage costs caused by an interest rate rise, an event which the Bank of England has indicated will take place in early 2016.
It explains that the profits of a standard buy to let investment can be wiped out by a 3% rise in interest rates, assuming mortgage rates increase by the same amount, as gross rental income is not sufficient to cope with higher mortgage interest repayments.
Even although HMO landlords pay for all household bills, the fact that the property generates a much higher gross rental income means that these costs are easily absorbed. The analysis suggests that the maximisation of income from a given size of property by creating extra rooms and renting them to multiple tenants means HMOs can generate rental income that is up to four times higher than the rents achieved in a standard buy to property.
Previous analysis carried out by PPP has shown that rental income is a far more stable and dependable source of return than capital gains, dispelling the myth that the success of any buy to let investment is mostly about rising house prices.
From 2010 to 2012, investors operating in both the standard BTL and professional HMO market were sustaining capital losses. It was only in 2013 and 2014 that capital gains began to recover but in contrast, rental income consistently increased throughout the same period for both asset classes, albeit at a much higher rate for HMOs, the report says.
It also points out that the best way that landlords can ensure their investment can cope with an interest rate rise, and any other unexpected costs, is by planning ahead and having a good understanding of the financial performance of their portfolio.
Research carried out by PPP in 2014 showed that a severe lack of research and poor planning is preventing many buy to let investors from maximising their income. A quarter of buy to let investors sought no advice and carried out no research before making their property purchases and a staggering 93% had no five year plan for their investment.
Separate research by PPP shows that landlords are also prone to miscalculating their returns. Some 12% landlords do not take any costs into consideration when calculating the financial performance of their buy to let portfolio. In addition, one in four landlords pay mortgage interest but do not take this into account.
‘In recent years, there has been an influx of investors to the buy to let market, with bricks and mortar proving to generate returns that outperform all other asset classes. However, not all buy to let is equal, and our data shows that HMOs generate much higher rental income than standard buy to let properties. HMOs will therefore be an attractive option for investors looking for a lower risk strategy that achieves a strong level of income,’ said Steve Bolton, chairman of PPP.
‘With many changes on the horizon for landlords, including the proposed restrictions to mortgage tax relief and looming interest rate rises, it’s never been more crucial to have a decent cushion of rental income to absorb any rising costs,’ he explained.
‘However, many landlords are failing to correctly calculate their returns, and our earlier research shows that a worrying number entered the buy to let market with very little forward planning. Without a clear picture of what they earn from their investment, a landlord is more vulnerable to market changes. Landlords must have a clear strategy and plan ahead to be able to accurately assess how futureproof their investments are,’ he added.