Refinance HMO – some top tips to get the best HMO remortgage valuation

Refinancing of HMO properties

More and more investors are turning to HMO properties as a great way to generate good cash flow. And for those investors who wan to momentum invest, the first question about refinancing is often: ‘how can I maximise the valuation I achieve for a remortgage and leverage enough borrowing to release funds for the next project’.

Property is an expensive game, and HMO’s are certainly no exception. As a general rule, an investor needs a larger deposit and also funds to renovate the property. Where no renovation is required, work is still often needed in order for the property to comply with the ever evolving legislation and licencing that surrounds HMO’s.

Hence the reason why so many investors want to carry out the relevant works, get the property tenanted and then quickly refinance in order to release fund for the next project. And in many cases, investors get resistance from both lenders and surveyors when trying to accomplish this. So the question is, how do investors achieve refinancing and using the funds released to momentum invest?

Firstly, I often refer to Steven Covey and his fantastic book ‘7 habits of highly effective people’ in this regard. You can apply all of those habits to momentum investing, however, ‘habit 2’ is particularly important. That habit is ‘Start with the end in mind’.

Nothing can be more true when looking to momentum invest. One can define the ‘end’ how you want. The ‘end’ of your whole property journey (ie retirement or exit of your portfolio as an example). And here is another example, if the ‘end’ is an investors exit from property, then that is the end of the book so to speak. And to successfully momentum invest, one needs to look at the end of the first chapter as well as the end of the book.

So what is the end of the first chapter? It is the point where the property serves the investor. Perhaps an investor buys an old tired B&B and converts it to a licenced and freshly refurbished HMO. Or buys a standard residential home and converts it to a HMO. Whatever the case might be, the end of the first chapter is where the refurbishment has taken place and the property is fit for its new purpose – ready to let as a HMO.

This is a very good ‘end’ to look at when planning. So envisage this at the beginning. Understand what the property looks like, what the property is worth and what a surveyor is likely to value it at. Because this figure is pivotal to ensuring the right plan develops and the property can be refinanced to pull all or some of the monies back out. We’ll deal with the calculations we use to identify a realistic commercial valuation later on in this blog-article.

Once that figure is established, the next figure to identify is how much the refurbishment is going to cost. Invest time researching this and get a figure as accurate as possible and then add at least 20% for contingency. If you have a cookie-cut type formula then this is of course easier to work through.

When you have both the end value when done and the cost to get it in that position, you can establish how much you pay for the building. Normally for a HMO, 70 or 75% of the end value is available as a loan. And by knowing how much you expect on remortgage will result in a realistic figure that you can offer for the property. You may choose to literally offer the net figure, meaning that all costs incurred etc will result in a position where you can remortgage and have all of your funds back out of the deal on refinance. Or you may choose to leave a little skin in the deal when looking at these figures. Let’s face it, the vendor may not sell for that perfect figure. In my opinion, if you leave some funds in the deal, but they can be returned from the cash-flow of the property over the next 12-18 months, then that is good enough. This is where it is purely down to an individual investors interpretation of a good deal and also how much, if anything, the investor is willing to leave in the deal combined with the figure at which the vendor will sell. Always try to find the win/win position.

What about the six month rule? I hear you ask. If you are still hindered by the six month rule, then where have you been? When it comes to HMO’s, only the really antiquated lenders pay any attention to the CML 6 month guideline and prevent re-financing within 6 months.

Lenders such as Cambridge & Counties, Shawbrook, Aldermore Commercial and Interbay are just some that do not keep you held to a six month restriction on remortgaging. Some of the lenders that will make you wait are Kent Reliance and TMW.

Get the surveyor on side

Once the property has been completed – and only when completed including all snagging etc, should you get the surveyor around for the HMO re-mortgage valuation. It is also preferable to have the property fully tenanted. There is no better way to prove the properties desirability and the income it can generate than to have a full suite of AST’s from a fully occupied property. (Or a lease in place where you might be renting to a charity for example).

When it comes to getting the surveyor onside, make sure you have done your preparation. Get together your own report on what you consider the property to be worth. The report should contain the following:

  • Schedule of works – always have a detailed schedule of works which shows what you have done to the property. For most commercial lenders, they will insist this is ‘costed’, however, it is often better to use an uncosted schedule if you can. We recommend preparing both as part of your project planning and that way you have both on hand at this point. The fact remains, a schedule of works should be drawn up before you purchase the property as due diligence initially, so you’ll just need to add any additional works that had taken place and have this ready for the re-mortgage application post completion of the refurbishment works.
  • Before and after pictures – don’t be shy with including pictures in your report. I have been asked in the past why I recommend ‘after’ pictures, after all the surveyor is right there, seeing the property in its ‘after’ state. However, bear in mind that the surveyor sees multiple properties per day – if you want them to remember yours as top of the list, particularly if you have done a high standard refurbishment, then I’d always recommend plenty of after pictures as well as dark and dingy ‘before’ pictures.
  • Recent comparisons – now I accept that recent comparisons can be tricky. If a HMO has recently changed hands in the area it is not always the best means of comparison. That is because the majority of HMO’s that are for sale in the market place are for sale because the existing landlord is retiring, or down-sizing their portfolio and the properties they off-load are often tired. So if you have a freshly refurbished, shiny new HMO, you don’t want it compared to some old slum. So here is the point, do your research and know what HMO’s have recently sold in your area. Find out about their condition and include in your own report a brief note about that property, its address and why it was not worth the same sort of value. If you can find the comparison data, you can be sure the surveyor can too, so head it off in advance. If you have any further comparison data that will also potentially beneficial. Perhaps you have had another HMO valued recently, or if you network with like minded investors, perhaps they have had one valued recently – even if for remortgage. That detail is better than no detail, so include it in your report if it helps justify the valuation you are going for.
  • AST’s or Lease agreement – It’s best to refinance with the property when it is fully let, that way you can firmly establish market rent and therefore potentially strengthen the commercial value. Make sure all of the agreements are available for the surveyor. More and more HMO investors are renting to Charities and Housing Associations on a lease. If this is the case, have the lease available.
  • HMO Licence – If your property needs a licence, make sure the licence is in place. In some parts of the UK councils allow you to start letting the property as soon as your licence application is submitted regardless of whether it has been granted. However, from the perspective of maximising the value of the property at the point of applying for your HMO re-mortgage, it’s best practice to have the licence issued and in place, available to show the surveyor.
  • Market demand – it is important to establish market demand for your property. Go on to the Spare Room website and the like, to establish demand and report this. If your tenants leave the property, how quickly will you get the rooms occupied? By establishing their is demand in an area you will satisfy the surveyor that the room rates you are commanding from your AST’s could be easily be achieved again. The other important aspect to this is that the lender and surveyor are more likely to support a commercial valuation if the property had high level demand as a HMO. If the surveyor concludes that the best way to sell the property is not a HMO ‘going concern’ but convert back to a private residence, they will be much harder on the valuation they give. This is because they factor into the valuation what would happen if this goes wrong and the lender takes possession of the property – if they would have to convert back to a family residence before selling, that expense is factored into the current value of the property. By positioning the surveyor to support high HMO or room rental demand, this safety measure of converting back to a private dwelling is much less likely to hinder a commercial valuation.
  • Strength of Covenant – The easiest way to illustrate strength of covenant is to put it in full commercial terms – imagine a shop being offered let; who would be the better tenant, Costa Coffee or ‘Andy’s Sandwich bar’. Clearly, more value would be put on a long lease from Costa Coffee. The principle also applies to HMO’s. In this instance provide the surveyor with a written synopsis of your tenants. Are they blue-collar workers? Are they on housing benefit? If the latter, it’s not going to be an issue for the lender or the surveyor provided you have positioned the case properly from the start. However, you might also include the steps you have made to ensure you receive your rental payments. Such as Escrow or having the benefit assigned. Whatever you have done in this regard, get it documented to strengthen your proposal. If rental payments are robust, this gives additional confidence to the lender and surveyor. You may also have a long lease to a Charity or Housing Association, and again, this should be included, preferably with the latest audited accounts for that organisation if you have them. That does assume that you as the property investor have also checked that the accounts are profitable before accepting the lease of course.
  • RICS valuation report – at Harvey Bowes, we always recommend getting your own RICS surveyor to undertake their own valuation of your property. This gives you a professional valuation which will be harder for the lenders surveyor to fight against. Especially if you have a good relationship with a local surveyor who understands what you do. In some circumstances it may be possible to have the same surveyor produce a report for the lender. The valuation may not be exactly the same, however, it can work well. This is easier to accomplish with commercial lenders than with more main stream lenders such as Paragon, Kent Reliance or TMW.
  • Clear business plan- it sounds pretty simple, but it is certainly important! Three paragraphs is all it may take, just to say… “this is my experience, this is what I’ve done with this project and this is what I’m going to do with the money released by re-mortgage”. If you are momentum investing, that latter point is that you will re-use these funds for further property investment which positions the money as safe in comparison to stating that you are buying a car, going on holiday or going to the casino!

All of the above should be put into a report and handed to the surveyor at the property. As a professional investor it is always worth meeting the lenders’ surveyor on site. Simply hand them your report containing the above. I always say “this is my research, I hope you find it useful”. Simple as that.

Another great tip is to make sure the surveyor has access to all rooms. It is technically a requirement of the report that they do get access to all rooms. So if one room is locked and you forget the Key, or one tenant is awkward, the surveyor has to either make another appointment to come back and view that one room or take ‘a view’ which will compromise his/her position and potentially compromise your report.

How to value a commercial HMO  

The following formula is a rule of thumb. It is not a hard and fast rule. And more importantly, no-one can guarantee that when a surveyor goes out to your property and values it, that they will give a full-blown commercial valuation. It depends on so many factors.

How ‘commercial’ is your HMO? The more ‘commercial’ a building is, the more chance of a strong commercial valuation is. This is about the look and feel of the building, the size of the building and the regulatory/licencing requirements that apply. So if you have kitchenettes, en-suites and such like facilities the building is ‘more commercial’. So too if it needs to be licenced. For some lenders there is also the ‘lettable’ rooms, or bedrooms. 7 Bedrooms and above again makes the building ‘more commercial’ than a smaller HMO whether it needs a licence or not. So the best way to establish to the commercial valuation is to talk it through considering all factors. Many investors who use Harvey Bowes for financing their projects often run the numbers and circumstances through to get that wisdom needed to find the right value.

The calculations we use are based on area as well as income. We would normally use a multiplier of somewhere around 7.5 – 11 depending on where in the country a property is and what the surrounding area is like. Once that multiplier is established, the rest of the formula is easy.

Take the gross annual rent of the property and multiply it by the figure established. So, for example, a six room HMO in Cross keys, South Wales recently achieved £250 per room per month. That’s £18,000 per annum and the multiplier for that area is 8.5. £18,000 x 8.5 = £153,000

Is that realistic? The next guideline is to establish the standard bricks and mortar value of that property as a family dwelling. In this instance it would be around £125,000 – therefore the uplift to the commercial valuation is not huge and the value can be established as realistic. However, if in this instance, the value of the property was £90,000 then we would use a formula to uplift that bricks and mortar value by 130%. 130% of £90,000 is £117,000 – therefore regardless of the multiplier, the commercial valuation would most likely be held back in this instance by the valuer as the area commands a lower value. Therefore in the event of a lender having to take possession and sell the property, the sale price won’t reach a full commercial valuation. Hence the sensible restriction.

The 130% cap is put in place to factor in a safety zone we see employed by many surveyors. Take for example where a property value is low, but the yield if fantastic – you can’t expect a commercial valuation to be hugely more than the value as a family dwelling. However, where yields are lower and land values are higher, such as London, Oxford, Poole and such like, the cap rarely applies because even using the higher multiplier of 10 or 11 the total figure does not reach 130% of the value as a family dwelling.

Another two equations have to be met in order to reach a robust commercial value. The first is that the yield reaches the anticipated yield for the area at the new commercial value. This is a simple calculation of the gross annual rent divided by the commercial value expressed as a percentage.

Then the final figure used should be in relation to the loan size. Normally, the loan available is up to 70% or 75% of the commercial valuation. But at the same time it will normally be capped at around 90% of the value as a private dwelling – this applies to smaller HMO’s in the main. It is therefore possible, that while all the other calculations are done, the surveyor will limit the commercial value by working upwards from the loan amount using this 90% cap.

Even if you are a seasoned investor, these calculations may seem complicated. However, it only takes a few practice runs to get the system and work through the end value of a HMO based on the factors presented. Always feel free to contact the team at Harvey Bowes to run through your figures and help you arrive at an informed and accurate commercial HMO valuation based on income as well as bricks and mortar.

For more information, contact the team at Harvey Bowes on 029 2175 4150.

About harveybowes
Mortgage Broker and founding Director of Harvey Bowes Limited. A mortgage broking practice with bases in Cardiff & Poole, UK. We take a fresh and positive approach to mortgage broking which pays dividends for both our clients and frankly, ourselves. The team at Harvey Bowes are expert advisors in all aspects of mortgages from residential to commercial and buy to let.

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