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How new HMO legislation will affect buy to let borrowing

Mandatory licensing of HMOs and new minimum room sizes come into effect on 1st October 2018. Landlords looking to remortgage or purchase HMOs need to know how the changes will impact their financing ambitions.

In case you were unaware, mandatory licensing of HMOs is being extended to include property occupied by five or more people forming two or more separate households regardless of the number of storeys – previously this rule applied to properties with three or more storeys. As usual there are caveats to the rule – mostly regarding self-contained flats and converted buildings - so do take time to read the full Order).

My colleague Chris Longhurst outlined some of the new conditions earlier this year in his webinar entitled EPCs and HMOs. (It’s worth taking a look if you didn’t attend or haven’t read the presentation since).

From 1st October 2018, the RLA estimates that an additional 177,000 HMOs will become subject to mandatory licensing in England alone. The new law is likely to affect how landlord’s finance HMOs.

Still in a draft Statutory Instrument but no less expected to be made into law and coming into effect at the same time, is the introduction of new minimum bedroom sizes within HMOs.

Rooms (i.e. bedrooms!) used for sleeping by one adult will have to be no smaller than 6.51 square metres, and those slept in by two adults will have to be no smaller than 10.22 square metres. Rooms slept in by children of 10 years and younger will have to be no smaller than 4.64 square metres.

The HMO licence must specify the maximum number of persons (if any) who may occupy any room and the total number across the different rooms must be the same as the number of persons for whom the property is suitable to live in.

Note, the new rules say “minimum” not “optimal” room sizes. Breaches of the rules could lead to a conviction of a criminal offence, which in turn, could result in an unlimited fine or civil penalty of up to £30,000.

Further, from October local authorities can also set minimum sleeping room sizes above the new legal minimum. They can also set limits on the number of people who can occupy each bedroom!

These changes will impact the buy to let market. Lenders, surveryors/valuers, landlords and brokers will be affected. Forewarned is forearmed as they say, but what are the implications?

Loss of rental income
Rooms which fall foul of the new minimums cannot be let; however, HMOs which are already licensed will only have to comply when the licence is renewed and, local authorities are obliged to allow landlords reasonable time to meet the requirement – up to 18 months before prosecuting.

HMOs which are currently subject to selective licensing will be passported onto mandatory licences.

It is not yet clear whether lenders will offer landlords a similar rectification period. We recommend that landlords take action now to find out if they are affected. We’ve already helped a few clients raise capital to make the necessary alterations so that they can remain compliant. If you think you might need to go down this route, do get in touch to talk through your borrowing options..

Reduced borrowing
If you discover that you have bedrooms that won’t meet the new requirements (as set by law or your local authority) and they can’t be altered, you could find that you are unable to remortgage on a like for like basis if the HMO was valued on a commercial investment basis.

If you do find yourself in this unfortunate situation and the HMO licence has a while yet to run, you might have no choice but to stick with your current mortgage provider and go onto the reversion rate. Whilst this is likely to increase your monthly mortgage payments, if you don’t default, you should be fine, i.e. business as usual.

If you do want to remortgage, you may have to accept that you won’t be able to borrow as much as before.

It’s also worth bearing in mind that since October 2017, lenders have been obliged by the PRA to assess a landlord’s entire portfolio when underwriting buy to let applications. Currently it’s not clear how lenders plan to accommodate the new HMO laws or what will happen if they discover HMOs which fall foul of the rules. At best, it is likely they will exclude rental income derived from non-compliant properties when stress testing the portfolio.

Upheaval to the valuation process
It’s standard practice for lenders to issue valuation guidelines to their surveyors. Come October, many of the current guidelines will be out of date, particularly the ones issued by lenders which value properties on a single dwelling basis, i.e. bricks and mortar.

These lenders should be issuing new guidelines now so that their surveyors can prepare. There is much to do in terms of training, roll-out and ensuring indemnities are fit for purpose. All this could lead to delays in carrying out valuations and may push up the price too. It’s unlikely that surveyors will absorb the additional costs, rather, they will pass on the cost to you, the landlord.

Lenders who are not thinking about this now may have no choice but to stop lending on HMOs from October until they have the right systems in place. Clearly this will have a knock-on effect for surveyors, landlords and brokers.

If you are a landlord looking for finance to purchase or remortgage an HMO, you might wish to consider getting ahead of the game. October will be here before you know it.

Fortunately, some of the specialist lenders, (i.e. Keystone, Paragon and Landbay) already issue specific guidelines for valuing HMOs. They employ expert surveyors which have the knowledge and capability to assess HMOs on a commercial investment basis. These experts regularly draw upon a wider than usual geographical area to gather evidence to compare rents, yields and property prices. They evaluate size of property, suitability of the building, number of occupants, running costs, Council Tax and compliance with rules and regulations (i.e. planning permissions, building regulations, EPC rating, type of licensing scheme).

They also consider whether the HMO should be valued on an investment basis or whether a bricks and mortar valuation is more appropriate, as is often the case with smaller HMOs.

It’s a very comprehensive process which includes measuring the size of each bedroom to ensure that they all comply with the local authority’s minimum requirements, (and from October the new legal minimum).

Fewer lenders lending on HMOs
But it won’t be all plain sailing for the more specialist lenders and surveyors. If a valuation report reveals that an HMO should be licensed but isn’t, or has rooms which no longer meet the minimum requirements, will the lender be obliged to inform the local authority? We don’t know!

And will local authorities grant licences on properties which have rooms below the minimum size? Will they trust landlords not to rent them out anyway? And if a licence is granted will lenders still be prepared to lend knowing there are unlettable rooms within a particular property? There are lots of questions which remain unanswered.

Yet again, brokers and landlords are awaiting action and announcements from lenders. This time, surveyors are waiting too. Inertia and silence could lead to a bumpy ride in a market that is still trying to get to grips with a whole raft of other tax and regulatory changes. We are keeping our ears to the ground and will give you an update on the situation as soon as we hear anything, so do make sure you subscribe to our weekly investor update. Or give us a call on 0345 345 6788 if you have a more pressing need for finance.

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