Houses in Multiple Occupation (HMOs) are the most stable and profitable form of buy-to-let investment, according to analysis carried out by Platinum Property Partners (PPP).
It says they protect landlords against higher costs caused by an interest rate rise.
The firm said that HMOs are intrinsically geared towards maximising rental income by letting each room on an individual basis. Recent research for PPP has revealed that compared to capital gains, rental income for all types of buy-to-let is by far the most dependable and stable source of return on investment.
HMOs landlords are therefore best positioned to absorb the higher mortgage costs caused by an interest rate rise, an event which the Bank of England has indicated will take place in early 2016.
Profits of a standard buy-to-let investment can be wiped out by a 3% rise in interest rates (assuming mortgage rates increase by the same amount) as gross rental income is not sufficient to cope with higher mortgage interest repayments.
The HMO property already has higher monthly mortgage interest payments due to limited product availability, the complexity of the model and the amount of tenancy agreements on any one property. Should rates rise by 3%, these mortgage repayments would rise by £426. However, because the HMO property generates a much higher gross rental income of £3,298, these extra costs are easily absorbed, with enough money left over to still earn a profit (£2,139 per month, down from £2,565).
This is still the case despite the commonality that HMO landlords pay for all household bills, which typically amounts to £533 a month, leaving £1,606 profit.
PPP said that a key characteristic of HMOs is the maximisation of income from a given size of property by creating extra rooms and renting them to multiple tenants. Based on PPP data, the average monthly rental income for a HMO property in 2014 was £3,298.
In comparison, the average monthly rent in the wider buy-to-let market in 2014 was £754. This data suggests HMOs can generate rental income that is up to four times higher than the rents achieved in a standard buy-to-let property, the firm said.
Previous analysis carried out by PPP shows that rental income is a far more stable and dependable source of return than capital gains.
From 2010 to 2012, investors operating in both the standard buy-to-let and professional HMO market were sustaining capital losses. It was only in 2013 and 2014 that capital gains began to recover.
In contrast, rental income consistently increased throughout the same period for both asset classes, albeit at a much higher rate for HMOs.
Research carried out by PPP in 2014 showed that a severe lack of research and poor planning is preventing many buy-to-let investors from maximising their income. A quarter of buy-to-let investors sought no advice and carried out no research before making their property purchases and 93% had no five year plan for their investment.
Separate research by PPP shows that landlords are also prone to miscalculating their returns. 12% of landlords do not take any costs into consideration when calculating the financial performance of their buy-to-let portfolio. In addition, one in four landlords pay mortgage interest but do not take this into account.
Just 21% of investors use the most effective measurement methods when calculating their returns (Return on Investment and Return on Equity) and 23% of UK landlords do not measure the return on their buy-to-let investments at all.
Steve Bolton, chairman of Platinum Property Partners (PPP), said: “In recent years, there has been an influx of investors to the buy-to-let market, with bricks and mortar proving to generate returns that outperform all other asset classes. However, not all buy-to-let is equal, and our data shows that HMOs generate much higher rental income than standard buy-to-let properties. HMOs will therefore be an attractive option for investors looking for a lower risk strategy that achieves a strong level of income.
“With many changes on the horizon for landlords, including the proposed restrictions to mortgage tax relief and looming interest rate rises, it’s never been more crucial to have a decent cushion of rental income to absorb any rising costs.
“However, many landlords are failing to correctly calculate their returns, and our earlier research shows that a worrying number entered the buy-to-let market with very little forward planning. Without a clear picture of what they earn from their buy-to-let investment, a landlord is more vulnerable to market changes. Landlords must have a clear strategy and plan ahead to be able to accurately assess how futureproof their investments are.”