The easy part is deciding to invest in property over anything else. Now we’ve got to decide what kind of property suits us best…this is where the real work begins!
In Part One I compared buy to let property with stocks and shares. Financial comparisons and analysis of pros and cons are important, but the critical consideration is the ‘why’ behind your investment.
In this article I’m going to take you through a similar process and consider the various residential property types, their pros and cons and their typical returns:
- The ‘family’ home, aka a single let;
- Apartments (yes I know they’re a single let, but there are important differences to a regular house);
- Holiday lets; and
- Saving the best ‘til last, HMOs
Back when we started, we spent a long time looking: researching different types of property and spending weekends driving around various locations; towns, cities and holiday honeypots. We spoke to estate agents both openly as investors-to-be and also undercover as pretend renters. We spoke with other investors and landlords to get their views. We spoke with mortgage advisors. We read. Lots. We had spreadsheets. Lots and lots. In short, we did all we could to satisfy ourselves that we were making a sound decision that we wouldn’t regret. Of course, we didn’t know for sure how it would pan out, but we left no stone unturned. The process was exhaustive.
And where did it lead? To HMOs.
A HMO (House in Multiple Occupation, otherwise known as a house share) is by far the highest earning and lowest risk property type. But our search didn’t lead straight there. We considered many other types* before settling on HMOs.
In our area of search, encompassing Lancaster, Kendal, the Lake District and surrounding areas, the difference in potential returns on a property worth approximately £180,000 were striking.
Realise this only considers the gross yield, i.e. the rental income expressed as a percentage of the property value. It does not include for any capital gain and there is no leverage factored in which could increase the overall return (more on leverage in Part Three).
Single let (i.e. a ‘family’ house)
The ‘family’ house aka the single let can take many forms, but what I’m referring to is a house that contractually is let to a single tenant. Regardless of whether there is just one person living there, a couple or a family, there is one ‘tenant’ and they have exclusive use of the whole property (I do however consider apartments separately below, although technically they fit the bill as a single let).
Finding, financing and purchasing a property to be a single let is simple and cheap (compared other property types), and there is a large market to choose from.
With just one tenant, and hopefully a low turnover of tenants the management is much less intensive than a holiday let or HMO. This means it’s not just easier but also cheaper to manage.
But what you gain in ease you lose in financial return.
Whilst the easier management means you keep more of the gross rent, a single let is still at the lower end of the spectrum of financial returns.
In our search we found we’d be lucky if we had much left over after mortgage and maintenance costs each month, and for us monthly income as well as capital growth was the goal.
A single let also has a high risk of void periods. If your one tenant in a single let pays late, that’s 100% of your rent late. When they move out the entire property is empty and not earning.
If one tenant in a 5 bed HMO pays late, that’s only 20% of the total rent late, with 80% still on time. Likewise when they move out it’s only part of the property which is empty.
Too many late payments or empty months and a single let can quickly turn into a serious cashflow problem.
A higher yielding property was what we were looking for.
I’m not going to lie, the idea of a nice apartment in a vibrant city is exciting, especially when coupled with the potential for strong capital growth of a major city, say Liverpool or Manchester.
The entry level price can be a lot lower than a traditional house. Demand from tenants, assuming you’re in a decent location should be reliably high, meaning easier letting and less void periods…which all equals a better return on your money.
But here’s what I don’t like about apartments: what you’re buying when you buy an apartment is a small part of a bigger building. A box within a box. You look after your box, other owners look after theirs and a management company looks after the fabric of the building as a whole; communal spaces, hallways, lifts, roof and so on.
Maintenance of the wider building- it’s general state of repair and decor etc- is therefore not something you control. Taking this one step further, when a building maintenance issue or problem stemming from another apartment (a leaking pipe for example) is affecting your apartment, it’s not fully within your control to remedy. Take it from me, this can be a problem.
Then of course you must remember that you don’t really buy an apartment, you just lease it (that’s why it’s a leasehold). The ability to renew the lease is a legal right, but it comes at an expense (£000s). Whilst the value of the property itself may appreciate, the value of your leasehold, if let to run down substantially will depreciate until you pay to renew it.
These points aren’t deal breakers, but they’re factors that need considering.
Yields can be in the region of 5-7%, which again with potential for strong capital growth is attractive, buts it’s still a long way from what we can achieve with a HMO.
Now this isn’t meant to sound too down on apartments. We love them and we love cities. We still own one. In the future I think we’ll have more to do with apartments again, but right now the financial returns are just not strong enough, and they don’t outweigh the downsides.
You don’t have to live in a holiday destination to purchase a holiday let, but for us living on the doorstep of the Lake District makes it an obvious option.
As with anything, there are advantages and disadvantages.
But before considering them, you need to determine your priorities.
Let’s get the #1 disadvantage out of the way first. Management. It’s intensive: weekly changeovers; year round marketing; managing bookings and more. Most people sensibly outsource that to a specialist holiday lettings management company, but it’s not cheap.
Surely the obvious advantage outweighs this: a holiday let comes with the added bonus that we could use it as a holiday home ourselves now and then (and why not friends and family too?).
An income producing asset that also gives us a summer holiday…too good to be true? That depends on your priorities.
If you’re looking for a holiday home primarily to use personally, any small rental income is a bonus.
But if you’re investing to achieve a strong financial return, using it yourself defeats the purpose.
How much income do you think your asset is producing when you’re staying in it during peak season?
And are you the generous one who lets friends and family stay for free (goodbye income), or the miser who charges them full price? It’s a losing situation whichever way you look at it.
Now, full disclosure: we have not researched every type of holiday let available and we certainly haven’t done extensive research on the almost endless locations out there. Our research has comprised a relatively brief look at a number of houses and apartments in three different holiday destinations across the UK, but none in exhaustive detail.
Why not? We never found anything that looked attractive enough at a high level to warrant digging deeper. That’s not to say it isn’t out there, in fact a closer look at this sector is something that’s on the cards in the not too distant future. But for now, a holiday let just didn’t cut it.
A HMO is a very powerful investment.
By taking a regular house and letting out each room individually, the rental income you can achieve can be double what you would expect from letting it as a family home.
They provide arguably the strongest monthly cash flow coupled with the lowest risk of void periods.
But what is a HMO and why is it so powerful?
Instead of a technical description of an HMO which you’ll find in 0.001 seconds on Google, let me describe one of ours, aided by some headline numbers:
A large Victorian terraced house in a central location. Nice street, loads of character, walkable to the city centre, shops and public transport. In short, a desirable home in a popular location. The market rent if it were let as a family home: somewhere between £650-£800 per month.
However instead of letting the property as a whole, it can also be let room by room. The market rent for a room is anywhere between £65 – £115, depending on the quality, amenities and service. That’s per week, across 6 bedrooms (or however many your HMO has).
Taking an average £90 per week that’s ~£2,340 per month.
Top of the range in our area would gross ~£2,990 per month.
Another benefit of a HMO is the risk of voids. If one tenant in a 5 bed house pays late, that’s 20% of the total rent late, with 80% still on time. If your one tenant in a family home pays late, that’s 100% of your rent late. Too many of those and that can quickly turn into a serious cashflow problem.
Management is more intensive however: you have multiple tenants with their own demands and requests as opposed to just one; running costs are higher due to the increased wear and tear on the house (and bill are often included within the rent); and it’s likely you have a higher tenant turnover.
Whilst we’re on downsides, the regulatory demands are higher with HMOs, and finance costs are typically higher than for a single let (although the increased yield more than compensates for these increased costs).
They must be out there, but we haven’t found a managing agent that does well with HMOs. We therefore choose to manage ours ourselves so we know that both our tenants and our properties receive the best service, without fail.
Now, there are HMOs and there are HMOs. Despite it being 2016 there are still some which are in an unacceptable physical condition, managed by agents who are at best incompetent, and frankly should be shut down. We hear tales of woe from these operators of a saturated market and a string of problem tenants.
Most are distinctly average, acceptable but never exciting.
And a rare few are a beacon of quality in a busy market place. High spec, spacious, with good management. These distinct few are created to be excellent homes, stylish with an obvious intention to be the best on offer. The only stories we hear from these operators is of high demand, respectful tenants (for the most part), and strong and secure financial returns.
It is not difficult to work out where these all sit on the spectrum of market rents.
We aim to operate in the top section of HMOs. To do anything else would not just seem like a financial mistake, it would run contrary to why we do what we do.
So there we have it, a summary of property types and potential returns leading unequivocally to HMOs as- in our opinion- the best investment choice if you’re looking for strong monthly income combined with long term capital growth.
One final point and last bang of the drum for HMOs: the inaffordability of property for first time buyers and ‘generation rent’ is a problem that the UK needs to tackle. Property investors are easy fodder for some parts of the media looking to apportion blame to this situation.
But not everyone wants to buy a property.
We aren’t dealing with ‘generation rent’, our clientele are young 20-somethings looking for social connections, flexibility and quality.
They’re in the early stages of their careers or higher education and they don’t want to be tied to one location for the long term. They don’t want solitude living alone. But they do have high standards and expect a high level of service, and why not?
Our HMOs provide the flexibility, social connectivity and quality that suits their lifestyle perfectly.
*we discounted commercial property almost immediately as we had neither a track record nor any familiarity with the sector.
Did you enjoy this?
Would you like to receive new articles and exclusive content first?
(we never share your details, we never spam)