When it comes to HMO property businesses, it’s not uncommon to encounter problems that’ll cost you more than you originally thought at the best of times. But this is a particularly significant challenge for HMO landlords as the cost of living is currently on the rise.
As we all know, anything can happen in the real world, which is why you should stress test all of your deals thoroughly before you consider purchasing anything or deciding what offer to put in. It’s certainly more important now than it has been in the last decade, and it’s so easy to get caught out if you don’t effectively stress test your deals!
With finding and appraising deals requiring more persistence and diligence nowadays, and even more so with the cost-of-living crisis, we’ll cover how HMO landlords can effectively ‘stress test’ their HMO deals moving forward.
10 Areas to Stress Test in HMO Deal Appraisals
There are a number of areas you need to stress to help you see what a deal might look like under ANY circumstances, particularly with the current market conditions. And looking at the bigger picture can help you make more informed decisions about every possibility and scenario.
While we can’t predict the future, there are ways we can prepare for what could be ahead and ensure a deal will still work – even with whatever comes our way! Here are the 10 key points HMO landlords should stress test in every HMO deal appraisal, in addition to updates on the current market conditions and tips for how to plan for the present and future.
1. Purchase Price
Firstly, factor in different levels of the purchase price and see what the entire deal looks like. Stress this component to know exactly where you can end up. This is particularly important as house prices have increased at record levels across the fast-moving property market.
Keep in mind that an asking price doesn’t mean that’s the true value of the property. It also doesn’t mean that a buyer will ultimately pay that to purchase it, so never be embarrassed about putting a lower offer in as the numbers just might not match up with the current asking price.
2. Interest Rate
As interest rates can influence your HMO deal significantly, it’s another important area to stress test. For starters, it can impact the cash flow at the back end of a deal. And if you’re paying more on your mortgage, you’ll have less to spend on other key areas of your business.
Because of this, a small change in interest rates can make a significant difference to the economics of any HMO deal. Currently, interest rates are on the rise after the record lows of recent years. Make sure you can handle any interest increases as rates are expected to continue rising.
3. Refurbishment Costs
When doing any refurbishment, certain problems may arise that could be beyond your control – and your contingency plan might not have allowed for them. Things can change significantly, and there is a range of reasons you may have to overspend on your refurb budget.
Refurbishment costs may be more because the price of materials and labour has increased. So, what happens to your deal if costs end up coming in 20-30% above your original budget? Would the deal still work?
4. Down Valuations
Another determining factor at the back end of a deal is the revaluation figure. You can go to different lenders or appeal disappointing decisions, but the reality is down valuations do happen.
Because of this, you need to have a contingency in place as this can completely change the outcome of a deal. Find out what happens if the deal is influenced by a down valuation. The results may mean you need to re-think the asking price.
5. Mortgage Loan to Value
As there is still economic uncertainty, lenders may appraise your deal and decide to insist on a higher deposit to reduce their risk. This is always something you should consider and be prepared for, so stress the loan to value ratio and keep in mind that this could happen at the revaluation stage as well.
6. Occupancy Rates
While it’s not impossible to maintain occupancy rates at 98-100%, it’s too risky to rely on this being the case. I always advise HMO investors to stress down their occupancy to around 80%. There may even be a global pandemic that’ll scupper all your plans and leave you with some empty rooms (too soon??).
Figure out at what point the deal would stop making money. This will also help you manage your expectations.
7. Rental Achievement
While rents are currently at high levels as demand has been strong across the private rented sector, including the HMO market, this may not last forever. Rents can fluctuate over the years, and while your new HMO might be looking fantastic now, it won’t look brand new over time as it wears down.
Factor in short and long-term adjustments to your rent, and see what this means for your property business. While of course, we’d all love to charge premium rent forever, the market may not allow it. So, stress your rental achievement, because HMO deals are particularly sensitive to this over the long term.
8. Utility Bills
Currently, many HMO landlords are worrying that their utility bills will exceed their monthly assumptions. If you’re offering all-inclusive rent, stress your bills as if tenants will be racking up the energy costs. This has been a particularly tough one to stress with surging energy costs and keep in mind that prices are expected to rise again in October.
But there are a number of ways you can help make utility bills for your HMO properties more economical. You may even want to budget for energy efficient improvements during the refurbishment stage.
9. Maintenance Costs
Ideally, ongoing maintenance won’t cost too much after a good refurbishment, but things can still go wrong. You never know, so stressing maintenance costs is important, especially as these kinds of costs could have increased in recent months.
10. Timeframes
While this is something you can’t fit into your spreadsheet and properly compute for, timelines should still be considered, particularly as so many things seem to be moving slower since the COVID-19 pandemic.
If you will be borrowing funds to purchase the property, then the clock will be ticking! The longer you don’t have tenants in the property, the more money you lose, and this includes the time it takes to refurbish and then advertise the property. Also, factor in interest costs if you were to run months over budget.
Stack Up the Deal
Now is the time to throw all of this information into a spreadsheet, or better yet, use the deal stacker inside The HMO Roadmap and play around with them! Once you stress these 10 points, I guarantee you’ll feel way more confident about your HMO deals – and especially so in the current cost-of-living crisis!
If you want to check out the deal stacker and have access to a plethora of other resources to help you start, scale, and systemise your HMO business, become a member of The HMO Roadmap today!
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 is the host of The HMO Podcast! Follow Andy on Instagram!