HMOs: UNDERSTANDING YIELDS
This post was inspired by a mini debate in the comments section of one of my last posts. I will try to cover the definition of “yield” and how it affects valuations of HMOs.
Let’s define “yield”:
Yield = earnings generated and realized on an investment over a particular period. It is calculated using the following formula:
YIELD = ANNUAL CASH INFLOWS / MARKET PRICE
· “Yield” is used to compare different investments apples to apples
· Higher the yield the more risk there is associated with it.
· A risky investment, should generate income at a quicker rate
· Market price = todays value (not the total renovation/purchase costs).
So, what does this mean in the context of an HMO?
Below is the mistake I see a fair amount:
“HMO yield is 15% because my all-in costs were £100K (purchase + development) and it now generates £15K a year”
This is incorrect because the market price is not £100K – this is renovation costs plus purchase costs.
Below is the corrected version:
“HMO yield is 15% because the current value (i.e. what it would achieve on the open market today) is £100K and it generates £15K a year”
This is correct because the current market price = £100K.
OK, but how do you determine the current value of an HMO post development?
The investment value of an HMO (back of an envelope) can be calculated using the equation below:
VALUATION = GROSS INCOME/YIELD
HMOs are interesting investments, because the market perceives HMOs to be riskier than they are. As the market matures – (as more lenders/agents/surveyors/operators/buyers come in) the yield “compresses” – the perceived market risk decreases. The capital value goes up – without you doing anything!
The less “risky” your HMO is the lower the yield. What are the risk factors affecting yield?
· Tenant profile
· Fabric / construction of the property
· Employment opportunities
· Tenant demand
· Operational experience
· Transport connections
· Surrounding yields of other businesses
· How adapted is the property for HMO use
· What planning hoops have been jumped through (C4 / Sui Generis)
· Are there any restrictions on this type of development in the immediate area (A4)
· How active HMO investors are in the area
HMO landlords might like to understand of yields of businesses in their immediate area, like small shops and guesthouses as a frame of reference.
If a bricks and mortar valuation is attached to your HMO this is the market value, and the yield of the HMO will still be determined by
ANNUAL CASH INFLOWS / MARKET PRICE.
Therefore if you have a much higher yield compared to BTLs in the local area. One of the explanations could be that the lender/buyer surmises there aren't enough investors that would buy the property on an investment basis to justify the commercial valuation. With agents/lenders etc, popularising HMO investments – this could change.
Typically, the commercial valuation is higher than the bricks and mortar valuation, this reverses the closer you get to central London.
One of the best books I've read on the subject is "Property and Money" by Michael Brett - it is heavy reading but definitely worth getting through.
Thanks to Richard Tpa @ https://www.thepropertyadvantage.co.uk/ and Ro Sham'o @ https://finuraproperty.co.uk/ for helping me research this post. (N.B. I will cover "net yields" in another post)
If you agree/disagree, or what I have written is incorrect - let me know below. Always keen to learn.
#toptips #property #commercialproperty #hmolandlord #hmo #hmoproperty #landlords