HMO Rents Set To Rise 50%

Rent-Increase

 As part of our response to the consultation on Additional Licensing, we asked our Vice Chair, local landlord and long established letting agent, Alwin Oliver to outline the economics of HMO's from the perspective of the tenant, the landlord and the city – as we are convinced everyone just assumes we are making huge profits at the expense of all around. We were not surprised to see Alwin's analysis prove this to be untrue – we knew that already – but what did surprise us was the fact that if Additional Licencing drives the smaller HMOs and landlords out of the market, the median renter will now find him or herself in a much more expensive 'Super HMO' which is why we believe the median rents will rise 50%.

Don't believe us? Then read on and Alwin will explain….

The HMO Economy - The case for tenants and landlords

Portsmouth legislators are proposing additional licensing for small (3 & 4 bed) Houses in Multiple Occupation. The licensing fees can only be used for the operation of the scheme. Licensing cannot be used as a fund raiser for wider enforcement of standards, for example HMOs that already require mandatory licensing. We have no dispute about that activity, enforcement against poor standards is always worthwhile if it is genuinely targeted at poor standards.

But some of the debate has been ill informed and occasionally abysmal. Put simply, the perspective of people living in HMOs and the owners of small HMOs, the ones being considered for additional licensing has not been sufficiently considered.

(Working) Tenant Economics

First the economic facts. Don't worry you will not need a calculator, but the numbers do need consideration, not least to avoid unintended consequences.

Let's start with the tenant perspective. A person over 21 on the minimum wage earns £9.50 per hour. In a city the size of Portsmouth there are tens of thousands of people in this bracket of the economy, predominantly concentrated in the "three C's" jobs, care, cleaning, and catering (or hospitality if you prefer). They need somewhere to live.

Not all of them will live in HMOs but many will, particularly those who are single. Let us put ourselves in their shoes and go shopping around for accommodation.

Assuming a single person on minimum wage works full time for a typical 37.5 hours per week they will earn £18,525 per annum gross. Without allowing for a pension, that yields a take home pay of £1378.75 or a little less if they pay into a pension (which we hope they do). Let's have a look what that gets them (the matter is more complicated for the many on Zero Hours contracts and even worse for those who depend upon benefits – but we will let you draw your own conclusions on the housing prospects for these groups based on the figures below).

Letting Agent Economics

As an agent I have several duties to my landlords and a duty of care to tenants and applicants. the one that interests us here is the affordability criteria. I use these to ensure that the landlord does not take on a tenant who simply can never afford the property, but I am also very aware that I do not do anybody any favours if I set a tenant up to fail by putting them in a property they cannot afford.

As an illustration, we recently had an applicant for a 2-bed flat, offered at £825 per month. On carrying out the income checks the applicant could only demonstrate an income of £850 per month. We politely declined and offered information about benefits but there is little doubt that had that person become a tenant, in short order they would be repossessed and seeking emergency accommodation from the city. In short, get this wrong and sooner or later the whole community pays.

Of course, when we adopt an affordability criterion, we must be objective and avoid direct or indirect discrimination. We should take a rounded view but avoid excluding potentially worthwhile applicants. In short, finance matters and nothing else relating to status should be considered. As an aside these things do matter to us, we are citizens, we live and work in the city and want to live in and contribute to a fair society. We also take a pride in our job, as do Councillors.

So, in setting affordability criteria we are objective. If an applicant wishes to rent a bills excluded property, for example a studio or flat the industry standard is that the rent should be not more than 40% of take-home pay. This figure aims to ensure that a tenant can afford to pay utility bills, council tax and so on and has sufficient funds to eat, buy clothes and go to and from work and hopefully at least a little left for leisure and community activities. Join a political party, perhaps.

Incidentally, Shelter and others define rent poverty as the rent being more than 35% of take-home pay, so our affordability criteria are a bit less stringent than theirs, although we are doing 2 slightly different things.

So, to recap, our applicant has a take home income of £1378.75 Our 40% criteria show an affordable rent for a bills excluded property would mean they can afford £551.50. Given that the Local Housing Allowance is £585 (if the applicant is over 35) you will not be surprised to learn that there are no flats or studios available in this price bracket.

It is worth noting that I can and should take savings into account (if for example the applicant has savings sufficient to cover the initial rental period, following the guidance from the Shelter "Jane" case (where a no DSS policy was held to be discriminatory because the applicant had savings) but one must wonder about long term sustainability. That though is for another day, and I will come to housing supply later.

Of course, some people in this income bracket live with family or friends, some are in relationships, perhaps with children and some will find their way to Social Housing, but let's stick with our single applicant, perhaps coming to Portsmouth for work.

As a city, we should extend them a warm welcome, newly arrived or lifelong residents alike and our housing policy should reflect that. As legislators, you will wish to achieve a welcoming City for all citizens with viable housing availability.

HMO Room Affordability

Now let us look at a room in a HMO. The first thing to say is that we can be a bit more generous on our affordability criteria, because the landlord is paying the bills and Council Tax. We allow 50% of take-home pay to be allocated to rent, still leaving enough for food, clothes work and leisure. Thus, our applicant can afford around £690 in a HMO room.

This helps a lot of people on less than full time hours as well, or those on Zero hours contracts, but conversely it also makes HMO rooms a popular choice for those saving for a deposit to purchase a property.

So, this brings us to what is available. HMO rooms like other properties vary considerably. We will look at the cost of ownership and operation below, but for now what can applicants get for their money?

With student numbers going down (20% drop on the last 5 years) and relatively costly halls springing up, a few "Ex Student" properties are available to our applicant in PO4 & PO5, at least for the moment. These are important as some at least will be the 3 & 4 bed properties that students tend to occupy.

Traditionally, these were offered to groups and excluding bills, with tenants paying bills themselves. But in recent years it has been all but impossible to let properties 'bills excluded' to students and recent price rises in energy have exacerbated this tendency.

For students a bill splitting service can be a viable option, thereby taking the risk of excess use away from the landlord, but for our professional applicant that is not an option. Bills included is what is expected and what makes sense, at least for the applicant.

Many of the properties on the portals (righmove, zoopla) are aimed at students, particularly south of Goldsmith Avenue, more professional rooms are found on the likes of Spare Room and Gumtree. Prices for the more economic options start in the mid £400-£500 range.

For a bit more luxury, perhaps an En-Suite, the Super HMO rooms (the 7 bed plus Sui Generis conversions) go from £525 to around £700+ if our applicant is looking for a short stay or "Propod" super high spec property. So nearly everything in the city is affordable or something a bit more basic will allow higher disposable income or accommodate those with a little lower provable income. So far so good.

HMO Room Economics

Let's now look at the economics of providing the accommodation. I have already hinted at 2 different types of providers, ex-student landlords and the swanky conversions with loft extensions and so on, often referred to as Super HMOs. These are typically high-end conversions, energy efficient, ensuite, good communal space, highly desirable but undeniably high-density housing.

There are lots in-between but let's give them names. Smaller HMO landlords, with 3-4 bed properties often, but not always, live close to their properties and tend to have bought as part of their pension arrangements. They typically own between 1 and 4 properties, do their own maintenance or use local handy person services. The money they earn from rent is often spent locally for the most part and tax yield to HMRC is not often minimised, through for example incorporation. I refer to them for shorthand as community landlords.

As local taxpayers and voters both they and their tenants are worthy of your consideration in preparing legislation, including additional licensing. But licensing does not exist in a bubble, any more than we could expect a single legislative instrument to tackle housing issues, HMO or otherwise. Other costs and national legislation all have an impact.

I have hinted at a major issue facing community landlords but I think we should tackle it head on - the extraordinary hikes in the cost of energy. One of our landlords with a 4 bed HMO wrote to us recently, telling me that he has checked his utility bills, they have risen from a little over £3,000 per year to £4,300 now, expected to approach £6,000 in October. His rental income, fully let, is a little under £1800 pcm.

Because there is a shortage of family let properties, prices have risen in the city, it seems by about 50% in the past 4 years. As a family let, unfurnished, or landlord expects the property to achieve around £1250 pcm.

Additionally, the pending abolition of section 21 proposed in the renters reform white paper impacts on his ability to manoeuvre. To him, the options seem simple "I will give notice while I still can" he told PDPLA glumly, but added "My workload will be down by about 90%".

So, with the Renters Reform Bill coming, the utility price hikes and the threat of additional licensing – the case for a community landlord to switch his/her small HMO to a family let is most compelling.

I can hear the silent cheer from Councillors and neighbours as I write, at least until the family turns up and actually has more cars than the HMO tenants (very few HMO occupants are actually car owners). But the fact is 4 tenants will now be looking for accommodation.

The tenants will have to go somewhere and this particular landlord is not alone, nor are his tenants.

The impact of a couple of hundred houses being sold or released onto the family market over the next year or two will not reduce rent significantly for those tenants, but once they are gone from the HMO market they are gone. Property of all kinds is subject to the laws of supply and demand and it is well to consider it as part of the legislative process.

In fact, we think the hike in energy prices will have a great impact on the economy of HMOs regardless of whether licensing is introduced or not – but if it is and the current proposed changes to standards remove an additional 1,000-1,500 rooms the city will face a dire shortage of affordable accommodation and it will be of its own making. Legislators need to be aware of the wider context in which they set forth licensing or any other proposals.

Super HMOs

But let's look at what is left standing, the super HMO. Every month seems to bring more applications and the public response has at times appeared to us near hysterical.

So how does it work and why are they springing up? A number of landlords have realised there is a gap in the market for high end and ensuite rooms in properties that almost feel like mini hotel rooms, often but not always ensuite, with large, luxurious communal spaces, thanks to permitted development rules.

These are sophisticated financially savvy businesses. As much property developer and entrepreneur as landlord, almost always operating from a limited company. Let's call them Company Landlords for now. They are well beyond the means of our community landlords, very few break through to this status.

For simplicity, lets look at an example, it pays to understand how it works. Our company landlord sees a property for sale, perhaps with C4 planning usage, perhaps in one of the shrinking areas with less than 10% density where C4 can be achieved without difficulty, but increasingly from community landlords selling up.

A typical example would cost around £250,000 perhaps a bit more. Typically they may be purchased without finance. Looking at the development stage, our corporate landlord already knows what the finished product looks like, they have either done them before or work with builders who have a proven track record.

A typical development would be under permitted development rules, and involve extensions to the rear, and into the loft. The finished product would cost around £150,000. Part of the development process will be to make the property as energy efficient as possible and include remote setting of the heat, but with a boost function for tenants. In any event the building will cost not much more to heat as a refurbishment than in original condition, but the costs will be split across 7 rooms not 4.

The rental income will have jumped from around £1800 to just under £4,000 and the finished product will be energy efficient, and highly desirable to our single tenants, who can afford it, even on a modest income.

The Company landlord, having got a highly desirable product to market, can now apply to a lender, on the basis of income, for a higher "commercial" valuation. In our example, the property may value at £500,000 and the lender may agree to lend up to 80%, so on to the next one and the number of 'Super HMOs' will continue to grow apace.

The company landlord will employ specialist builders, may well not live in Portsmouth but they are providing a product and a service that many in the community want and need. The whole operation will of course be highly tax efficient, in some cases going offshore. It may not be the biggest consideration for legislators, but neither should it be disregarded.

Our Conclusions

Our prediction is a significant increase in community landlords exiting the market, or repurposing for family let and a demand led net growth in company landlords creating more super HMOs. We have members who provide both, it is for the city to decide which is the preferred model, or if a mixed economy, not to do anything that skews the balance too much.

It may be too late for many because of energy costs, but serious reconsideration of extraneous space requirements for example, should be a priority, as should helping landlords with energy efficiency measures.

Looking at each party Applicants and tenants

Energy and other costs will have an impact, less so on super HMOs than smaller ones, I predict rent rises of around 10% in Super HMOs and up to 15% in smaller HMOs in order to keep them viable (variable rate mortgages are also on the way up)

Landlords

Some community landlords will convert to family lets, a great choice for ageing landlords, but one bad experience will put them out of the market. Tenant referencing will be the key to success.

Neighbourhoods

Small HMOs will reduce in numbers. Some will keep going, at least for now, but expect hundreds of properties to change, some will become super HMOs, the overall number of HMOs will reduce, but the number of HMO rooms will fall but not significantly and will be concentrated into less properties.

This may sound like a good outcome, but remember the rent differential between a small HMO (400-500 set to increase 15%) and Super HMO (525-700 set to increase 10%). The issue though is that Additional Licensing coupled with high rents available for family lets, increasing Council Tax burdens for HMO and energy prices seemingly rising exponentially, the number of small HMOs will drop significantly and the median renter will now be a Super HMO resident, so the median rent will rise from £517 (midpoint of 400-500 +15%) to £674 (midpoint of 525-700 +10%), an increase of 30% on top of the increase in today's rents (so in effect a 50% increase for the median tenant).

Also, because the homes that are sold or let as whole properties will go into the family market, the net impact will be an ever higher demand for parking which will be an unexpected consequence of Additional Licensing.

Summary

Overall, these proposals will push up rents (the median rent will jump 50%) – this analysis has looked at those in work who can afford to live in an HMO. The people who will suffer are those on benefits who currently struggle to survive in the cheapest HMOs as these will be pushed right out of the market.

Add to this the loss of community landlords and their positive input to the local economy, being replaced by corporate landlords who add little to the local economy and the net effect of Additional Licensing will be severely negative on the city, even before you consider the crisis of removing homes from the 1,000-1,500 people most in need of affordable housing in the city. 

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