HMO Gross Yields and what is reasonable?

HMO Gross Yields and what is reasonable?

10:59 AM, 25th January 2016, About 6 years ago 19

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I have recently seen an advert for a HMO for sale offering a 12.2% gross yield. As someone who operates several HMOs, I felt that this is perhaps not a very good yield at all, and I wondered what other landlords on here thought would be a reasonably good gross yield?net profit

My reasoning for dismissing the advertised 12% gross yield is as follows:

As a HMO has huge running costs, and higher turnover of residents, the “gross” yield is not really very useful when calculating the net profit from a property.

For example, I have some properties that produce more than a 100% gross yield (i.e. the rental income from the rooms is more than double the rent*/mortgage paid out each month), but to establish the actual net profit (before tax) you need to factor in the other likely costs, e.g. utility bills, council tax, furnishings, repairs, damage, wear and tear, rent arrears, void periods, HMO licence, letting/advertising costs, legal costs, maintenance, time spent visiting the property and doing admin, etc, etc. When all this is taken into account, the 100%+ gross yield drops to perhaps 20-30% net yield.

Although I operate in a different sector of the market, so my costs may be considerably higher than the costs on the particular property I saw advertised, nevertheless, I don’t think a 12% gross yield would generate a positive net yield. Therefore, any potential investor should be aware of these costs and would need to factor them in to their calculations of potential net running profit, and when this shows as being low or negative, then they should perhaps base their investment more on the potential increase in capital value of the property rather than the gross yield.

Gross yield does NOT = net profit.

* In my case I lease the properties from owners and then sublet them, so I do not pay a mortgage, I pay a rent each month, and my gross yield is the difference between income coming in and rent going out. (My net yield (before tax) is the income coming in minus ALL the costs going out).

Robert



Comments

by Robert Mellors

0:03 AM, 26th January 2016, About 6 years ago

Reply to the comment left by "Gary Dully" at "25/01/2016 - 23:22":

Hi Gary

I did consider going down the licenced HMO route, as several of my HMO properties have 5 bedrooms, so I looked at the necessary forms for applying for this, and found that as I lease the properties from the owners, it would be a bit more complex as the mortgages etc are in the owner's name and I don't have access to the information being asked for. With some of the owners it would not have been an issue, but with others I suspect it may be more complicated, e.g. where there are language barriers or lack of understanding.

As for my plans, I don't have any specifically relating to HMO licensing, but I guess it could perhaps be a case of charging the tenants more so as to cover the added costs, or, changing the properties back into self-contained family homes.

by Ross McColl

8:34 AM, 26th January 2016, About 6 years ago

The reason I think you believe 12% Gross Yield is so low compared with your 100% or more is because yield is calculated in relation to the value of the property itself and has no relation to the rent/mortgage payments. Gross Yield = value of property / turnover. Net Yield = Value of property / (turnover - costs).
Or am I missing something??

by Robert Mellors

9:17 AM, 26th January 2016, About 6 years ago

Reply to the comment left by "Ross McColl" at "26/01/2016 - 08:34":

Hi Ross

You are quite right about gross yield being based on the value of the property, but I believe the calculation is:
Annual rental income / Property value) x 100
So for example one of my properties in Sheffield is worth about £70k and I achieve about £13.5k annual rent, so this works out at £13500 / 70000 x 100 = 19.28% gross yield. This is similar to the gross yield in the example given by Gary.

However, in a rent to rent situation, like I have, basing the yield on the property's value has no real meaning as I don't own the property. Thus, my "investment" is only the monthly rent that I pay for the property, so do I work out my gross yield based on that monthly outgoing, or is gross yield totally irrelevant as it does not apply (in which case, what do I call it/how do I express it)?

by Ross McColl

9:32 AM, 26th January 2016, About 6 years ago

Haha. What an embarrassing mistake to make. To correct someone else with the wrong formula. I knew what I meant lol.
What you seem to be describing is the coverage ratio, or some form of it. Although I can see why you would describe it as your return on investment but you do not hold the value of the property itself.
EBIT/Interest Expense(Mortgage payments, or in your case rental expense)
I agree that gross figures in general have little value without knowing the net, but you are unable to compare the two ratios on their own in my opinion.
For you to compare what you are currently getting with what is being offered you would need to ask the question as to what you can rent these out for, to enable you to do a like for like comparison.

by Robert Mellors

11:55 AM, 30th January 2016, About 6 years ago

Reply to the comment left by "Ross McColl" at "26/01/2016 - 09:32":

So in the example property which would be producing a 19.28% gross yield, if I owned the property, then as a "rent to rent" landlord I guess I really need to call it a gross profit (rather than gross yield), as my gross income from the property letting is simply the difference between the rent coming in (from my tenants) and the rent going out (what I pay to the owner).

Once this theoretical "gross profit" is established, then deduct all the other costs associated with letting the property (e.g. damages, legal costs, rent arrears, voids, repairs/maintenance, furnishings, etc, etc), to give the annual net profit. I guess this is the bit that the accountant does each year, but what formula would I use to work out the % profit?

by Rob Crawford

15:33 PM, 30th January 2016, About 6 years ago

When anyone starts advertising or comparing rental yields I always ask, "how was the figure calculated". There are so many variables that can be included or excluded. I think this thread proves this to be the case. I use a (rental income less mortgage and costs / todays estimated property value) x 100. Even so the result will depend on what a landlord's mortgage LTV is and this will vary between landlords. To get away from the variables and to provide a figure for comparison purposes most advertising agents will use (the expected rent / advertised property value) x 100.

by Mike W

16:12 PM, 31st January 2016, About 6 years ago

Robert,
As RC has stated the generally accepted way of quoting a gross yield to take the annual rent figure and divide it by the capital value of the property. The term would also apply to your business even if you don't operate as an owner. Your business is a 'margin business', in a way like some shopkeepers who buy in potatoes at £150 per 1000 kilos and sell in the shop at £1 per kilo. The gross margin would be £0.85/kilo. If your other costs were £0.50/kilo, your net margin, before tax would be £0.35/kilo. And no I am not a potato seller.

Where I disagree with RC is the calculation of net yield. In my view it is the income minus costs excluding finance costs. The reason to exclude finance costs is because the finance cost is a variable dependent on wider country factors, your personal standing and the nature of how you are running the property. Those two latter factors vary by owner. For example you may get a different interest rate depending upon whether you operate as an HMO or rent to a family.

Calculating the net yield in this way allows a quick check on whether to finance the property. It would be (with one exception) rather silly to borrow money at 5% to invest in a property whose net yield is 1%. The one exception being where the capital value of the property is expected to rise by more than 4%pa. But of course that means operating at a finance loss for a period.

The above also allows comparison of investments. Would you invest in a property whose net yield is 5% or in 'national grid' shares currently yielding 4.2%. The capital value of both could go up or down.

by Jonathan Clarke

17:30 PM, 31st January 2016, About 6 years ago

Yield is a generic term and its value can vary tremendously depending on what formula one uses and what you are actually attempting to describe . I have some properties when i viewed which i used to describe loosely at 10% gross yield before i bought for back of a stamp DD purposes . However depending on how i structured the finance or what the refurb bill was that would maybe drastically alter the yield % return .

Some I could describe as infinity yield on the day of completion

(Annual rental income / Property value) x 100 is a very useful starting indicator of yield %. But the true yield % ( gross or net) of a property ( or indeed a portfolio) is much more complex and deeper than that opening calculation. It also is a fluid ever changing figure of course over the lifetime of a property

That initial calculation should only be used in my view as a springboard to then move into much more involved mathematics depending on how much or how little data you care to introduce into the equation
.

by Rob Crawford

17:58 PM, 31st January 2016, About 6 years ago

Reply to the comment left by "Mike W" at "31/01/2016 - 16:12":

Yes - I should have explained this is how I compare the yield between properties in my own portfolio.


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