Are we at peak HMO?

Is Peak HMO Here? 

 

Are we at “peak HMO?” Is now the time to crystalise the gains on HMOs? After seeing many HMOs listed at low sale yields on Right Move, I decided to list another HMO, 155 Colwick Rd, at a high price to see if there were any takers at a “buy it now” price. To my pleasant surprise it sold in February for £315k on the following statistics:

  • Asset: 6 bed HMO with Article 4 planning.
  • 155 Colwick Rd, Sneinton, Nottingham, NG2 4AP
  • Sale price: £315k (Feb 2022)
  • Purchase price: £111k (April 2014)
  • Capital Gain: +£204k (+166k after 38k CGT)
  • Gain +183%
  • Rental Income £28.8k
  • Sold yield: 9.14%

The 315k sale price was well within the 7-9% sale yield which is becoming increasingly common on Right Move for HMO’s in Nottingham and other Midlands cities. This largely has been driven by the effects of Article 4, a Council directive that was issued in 2012 which banned Planning Permission for new HMOs. The effect of this has been to restrict supply and drive a mini boom in HMO with confirmed C4 planning – showing the value of obtaining a Lawful Use Certificate.

 

Was the price logical? My research & data indicates that these compressed yields are getting to the point where it does not make much logical sense when compared VS other investments with a lower risk profile. E.g. Single BTLs, stocks etc. To illustrate this case, the operating/maintenance costs of this HMO are recorded as circa -£6k pa in my books and an agent (10%+VAT) would take another -£3.5k. Suddenly the seemingly healthy £28.5k income is only £19k net income before finance costs. A rather poor net 6%  yield! Which is illogical given the risk and work required VS other comparable investments such as standard BTL. Given the mortgage financing costs are usually much higher on HMOs than BTL, the net 6% yield once again is looking very overvalued.

  

To further add weight to the “peak HMO” thesis, in April there are several onerous additional costings coming to the HMO market, with the energy price cap rising on April 1st by 54%, operating margins will fall. In October the same will happen again and with Putin invading Ukraine, gas is only going one way! A conservative estimate using the KWH of the new energy price cap costings, model another +£200pcm onto the bills even with careful use! This would take another -£2.4k from the bottom line giving a very poor £16.6k net income and an even poorer net yield of 5.2% by October 1st 2022.

 

The only counter argument to “peak HMO” is the national minimum wage rises by +7% in April. This argument when using mathematics does not make sense as even if the +7% pay rise is passed on it would result in a new rent of £30.8k pa thus the net yield (after 3.5k agent costs, 6k operating costs & 2.4k price cap change costs) would still only be 6%! That said demand is still good and an assumption of 6% would be quite reliable, even if it is not a great net yield. 

  

To conclude the debate I would consider the HMO market to be at “Peak HMO” and it is hard to see the mathematical case for further capital growth, even with rental growth factored in. Surveyors clearly will need to take into account the increased utility costs, which will surely mean the current net yields are not sustainable. For the level of risk/rewards on offer the net yields on offer are too poor VS other asset classes.

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