Photo by Parable Property

Certain risks can completely change the economics of your HMO deals and whether you can complete or exit a deal. And how you enter deals as a HMO investor is intricately linked to how you exit them.

While exit strategies and risk management may sound dull, getting this right will make your deals much better from the front end! How you get into deals, what they look like, and their performance should largely be built upon what it looks like to get out of the deal or to get out of the first phase of the deal.

Read below or listen to the full episode on The HMO Podcast about the four essential considerations for HMO investors when it comes to risk management and exit strategies!

Common Risks for HMO Investment

Many HMO investors are guilty of focusing predominantly on the numbers and looking at rental income, voids, and interest rates. Yes, there are risks associated with these areas and they need to be built into the spreadsheet, but there’s so much more to it!

We’ve been in a shaky economy for some time now, which can impact the performance of our deals. There are other things that can impact us, such as planning delays, timeline or budget overruns, and unforeseen matters like getting unwell or things happening to your contractors.

There are a whole host of things that could impact your deals, and it’s not about trying to control all of them but considering the different eventualities, what we’d do in those circumstances, and building contingencies in.

If we don’t, our deals could fall down, and you could get stuck on bridge loans, fall out with investors, and lose lots of money. But if you get this right and really consider these areas from the start, it’s easy to avoid as we can build mitigations in at the front end!

1. Down Valuations & Missing Loan Redemption Dates

Let’s talk about the importance of mitigating the risks of down valuations and missing loan redemption dates. An entire project can hinge on the revaluation, so what if the valuation doesn’t come in where you want?

There’s always uncertainty with this, but there are strategies that can help you ascertain what a valuation could be. So, there’s an element of risk, and it’s fine as long as you understand it and build in the possibility of down valuations or less good ones. Sometimes as investors we’re too optimistic, and we may need to rain in our expectations!

It can be helpful to reach out to local surveying firms for a desktop valuation. It might cost a few hundred quid, but that could take a huge amount of risk out of your deal, especially if you’re relying on funds to pay back an investor or bridged loan or allow you to buy your next deal.

There’s also the risk of missing things like loan redemptions or the ability to redeem loans. You can’t remove this risk altogether, but there are things you can do to help absorb that. You can restructure a loan or agreement and think about certain changes or contingencies that you could put in place.

For example, a six-month bridge is pretty short and quite an optimistic timeframe to get into a property, develop it, and go through the refinance and valuation process. So, what about making it 12 or 18 months?

It’s important to talk about these things with your investors. Have conversations about the possibility of down valuations, how that might affect the deal, and what happens if you can’t get as much money back. Is there an ability to extend the loan? Does it revert to a slightly higher rate over a period of time? Could you give them some sort of second charge security?

2. Planning Delays & Uncertainties

Sometimes HMO investors can be cavalier towards the challenges, delays, and risks around securing planning permission. Planning is often not straightforward, and keep in mind that if you don’t get the planning you require, you’ll likely have an issue with getting a commercial valuation.

When a valuer comes in, they’re going to caveat it with the need to see the appropriate planning permissions and proof that you haven’t breached any planning laws. It’s also important to have the planning all signed off in readiness for your term lender.

For many councils, their planning timelines are so up in the air, and it can take them a long time for them to even make a decision. And there are additional uncertainties that you can face when it comes to planning, including nutrient neutrality issues and the impact of Article 4 directions.

Your lender will also scrutinise the likelihood of you getting planning permission, and that’s going to form a key part of your ability to actually get a loan in the first place! But what can you do to reduce and mitigate risks around planning?

For starters, involve experts like architects and planning consultants who really understand planning policies locally and nationally and know what it’s like to work with the local planning department.

If the council is slow or they don’t like certain things, it’s good to have a heads up about that. You can build that into your deal and any conversations you may have with an investor, and you might decide to take your initial bridge loan in a slightly different way.

You could also do your own research on local planning regulations. Sift through the planning portals and look at the council’s responses to similar types of applications. What’s been approved? What’s been rejected? How many amendments did they have to make? Did it go to appeal? You can then use this information and stack it into your deal.

3. Timeline & Budget Overruns

We’re probably all guilty of being overly optimistic about what can be done, how quickly it can be done, and at what price. I’m still guilty of being too optimistic sometimes when it comes to budgets and timelines.

It’s important to be realistic. If you make mistakes with your budgets and timelines, it puts a lot at risk. If your refurb overruns, you could miss redemption dates if you have a private loan or a bridge loan that you have to redeem.

Issues with timelines and budgets tend to stress relationships as well, including relationships with contractors, investors, and even relationships at home. Overruns can happen because we set unrealistic expectations. Sometimes we’re not on the mark when it comes to costs or our communication isn’t good enough. Beginner HMO investors can particularly struggle with this.

To mitigate certain risks, build detailed and thorough schedules of work. Tender jobs out, get multiple opinions on what things cost, and have the right paperwork in place. Instruct experts like architects to help with this, and consider bringing on a project manager.  

Timeline and budget overruns can cost you a huge amount of money – money that you maybe haven’t factored into your deal, which could put you into a lot of financial pressure! It could mean that the back end of the deal doesn’t look anywhere near as good as you hoped.

4. Unforeseen Issues

There are a range of common issues when it comes to HMO investment, including changes to market conditions and regulations, products being pulled by banks, interest rates being increased, people becoming unwell or going on holiday, or issues that crop up with a property you’ve purchased. These are out of your control, but they could all very well happen.

If the last 12 to 24 months have taught us anything, it’s that we just don’t know what’s around the corner. The only consistent feature about investing in property is that unforeseen issues come up all the time!

So, you need to think about what you’d do if these sorts of issues crop up at the front end. For example, what would you do if interest rates or inflation rocketed up? What if a certain piece of legislation was brought in very quickly?

Our job as HMO investors is to consider the worst-case outcomes. Consider what would put your deals under more pressure, how you’d handle these issues, and the strategies and risk mitigation tactics you could put in place.

Not only do you need to test these risks independently, you need to test them in scenarios where they might happen simultaneously! Have you had the right conversations with investors and brokers and considered different options if it didn’t pan out the way you planned?

It’s not all about changing the purchase price and trying to renegotiate deals up front. It’s about making sure that you’ve thought about all of the possible risks, you’ve had conversations about these upfront, especially with business partners and investors, and you’ve considered what you might do if something like that were to happen!

Be open and honest. When I’m talking with investors and business partners, I am incredibly transparent about what I see the potential risks as and how big or small I think those are. It’s important that you consider all of this going into deals to make sure that you can get out of them and be on the front foot.

Take all of this into account when you’re stacking your next deals up and having conversations with investors, business partners, and other stakeholders.

Keep on top of this and consider everything you possibly can to mitigate risks as much as possible and make sure that no matter what you have an exit strategy, whether that’s exiting the deal completely or exiting your first phase onto your term finance!

If you’re just getting started or scaling up your HMO business, head over to The HMO Roadmap, where you can find over 400 educational tools to help you start, scale, and systemise your business. And if you have any questions, join us over in our free Facebook Group The HMO Community.

 

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. He writes as a regular columnist in different magazines about a variety of HMO topics and is the host of The HMO Podcast! Follow Andy on Instagram!