In the world of HMO property business, it’s not uncommon to encounter problems that’ll cost you more than you originally thought. Maybe the refurb’s going to cost more because of issues with the materials, or maybe the bills and utilities will exceed your monthly cap. There may even be a global pandemic that’ll scupper all your plans and leave you with some empty rooms…
Anything can happen, which is why you should stress test all of your deals thoroughly before you purchase anything.
There are ten points you need to stress to help you see what a deal might look like under ANY circumstances. And by looking at the bigger picture, you can make an informed decision about every possibility and scenario.
Here are the 10 key points you should stress test in every deal appraisal!
#1 Purchase Price
Now, this is something you might not agree with because the purchase price is usually fixed (you’ve agreed to it after all) but you have to stress this point if you’re planning to buy at an auction house. When you’re in the auction room, you might get carried away by the excitement, so you really need to have a plan so you know what your upper bid limit will be.
So when you’re looking at the appraisal, first factor in the different levels of the purchase price and see what the whole deal looks like. Stress this component to know exactly where you can end up, and certainly have this conversation with your investor (if you’re working with one!) before the hammer comes down.
#2 Interest Rate
Interest rates can influence your deal significantly. It can affect the cash flow at the back end and if you’re paying more on your mortgage, you’ll have less to spend on other important aspects of your business.
A small change in interest rates can make a huge difference to the economics of any HMO deal, so try to stress right up to 6%. You can also stress beyond that to make sure you could handle any interest raises because believe me, the historically low rates we’ve become accustomed to won’t be here forever.
#3 Refurbishment Costs
When you’re doing a refurbishment, certain problems might arise that’ll be beyond your contingency plan. Things can change significantly — the planning inspector might insist on something different, certain issues with the builder might come up, or your initial plan might not pan out as you expected.
There are a number of reasons you might have to overspend on your refurbishment budget, so see what happens if your costs come in 20% above your budget — would the deal still work?
#4 Down Valuations
The revaluation figure is often one of the determining factors at the back end. You can appeal disappointing decisions if you need to or you can go to different lenders, but at the end of the day, down valuations do (and will) happen, and we need to have a plan of action for this event.
A significant down valuation can completely change the outcome of a deal, so you need to have a contingency in place. See what happens if the deal is influenced by a down valuation, and let this guide you in decision making — perhaps you need to re-think the asking price?
#5 Loan to Value (LTV)
Sometimes, lenders might appraise the deal and decide to reduce their risk by insisting on a higher deposit. Your deposit might be bumped up to 35%, and that’s not unfathomable considering the current situation. This is something you should consider and be ready for, so definitely stress the loan to value, and remember, this could happen at the revaluation stage too.
#6 Occupancy
It’s not impossible to maintain occupancy rates at 98-100%. But it’s too risky to rely on this being the case. My advice is to always stress down your occupancy to around 80%.
Try and see at what point the deal stops making money because this will help you manage your expectations with regard to occupancy.
#7 Rental Achievement
Let’s say your brand new HMO property is looking fantastic, so of course you’d want to charge premium rent for it! But your property won’t look brand new forever. Over time, it’s gonna wear down.
My advice is to factor in short and long term adjustments to your rent and see what will happen to your business. Because as much as you’d like to charge for premium rent forever, the market might just say no. So always stress your rental achievement because the whole deal is sensitive to this especially in the long run.
#8 Bills and Utilities
This is a tough one to stress because bills and utilities depend on your tenants usage, and that can definitely vary. Some tenants will use more gas, water, or electricity than others, even if you give them advice about being economic!
Which is why you should always stress your bills and utilities. Stress your bills as if your tenants will really be racking up the energy costs. This way, you won’t have to pay extra once the monthly bills come around.
#9 Maintenance Costs
Hopefully, ongoing maintenance won’t cost too much after a good refurb, but things can still go wrong — after all, it’s property we’re talking about! The boiler could break, a tenant could damage something, or there could be a leak. You never really know, so stressing maintenance costs is important. See what the deal looks like even if you have to spend a hundred pounds a month on maintenance.
#10 Timeframes
This is something you can’t fit in your spreadsheets and properly compute for, but timelines should still be considered. If you borrowed funds, then the clock’s ticking. The longer you don’t have tenants in your property, the more money you lose — and this includes the time it takes to refurbish and advertise. Factor in the interest costs and see what happens if you run months over budget.
Now that you know the ten points you need to stress, throw all of this in a spreadsheet and play around with them. Don’t forget to stress all of them together because, in the real world, all of these variables get affected in different ways — so it’s important to build a picture using all of the above.
Once you stress these 10 points, you’ll feel more confident with your deals! By imagining and preparing for different scenarios, you can build up your cash cushion to better respond to the problems that come your way, and if you need to, you can re-negotiate your deal to give you more of a margin for error.
For more useful resources and in-depth lessons, join The HMO Roadmap today and use our revolutionary ‘My HMO’ deal appraisal App to help stress test your deals.
About the Author:
Andy Graham is the founder and the lead trainer at The HMO Roadmap! He is also the co-founder of The HMO Mastermind and Smart Property, a specialist HMO property investment and management company. He writes as a regular columnist in different magazines about a variety of HMO topics and the host of The HMO Podcast! Follow Andy on Instagram!