Valuations

By Lisa Orme
Property Finance Specialist – Keys Mortgages

This is the one topic that I spend most of my time explaining!

It is quite clear that HMOs have garnered huge popularity of late, added to which there’s lots of people going around quoting ‘get all your money out’ and ‘HMOs are valued at 10 x rent’ – while lenders are keen to lend on them, it has forced them to tighten policy especially on valuations.

In summary, things are now taking shape and it’s becoming increasingly apparent as to when you’re going to get a commercial (yield) valuation and when you aren’t.

Simply put, if you could buy a similar house ‘next door’ the same as yours then you’re only going to get bricks and mortar value.

It doesn’t matter how many rooms you have, and I’ve seen this policy applied on a property with 8 rooms and 5 en suites, but the fact is in structure and layout it’s pretty much like any other house in the street. In fact, in one case a HMO property was down valued by the sum to turn it BACK into a family home!

These days the way to get a commercial valuation is to ensure a complete overhaul of the property and ensure its nothing like a family home. Clearly conversions and larger premises such as larger detached properties or commercial to HMO conversions are more likely to fit this bill than a flat or terrace.

Multiple kitchens will also help, though be careful on this as some lenders won’t lend if there are more than one or two kitchens.
Remember, even with a commercial valuation there’s two things to consider:-

1. The first myth I must dispel is that HMOs are valued on 10 x yield.

Commercial valuations are not 10 x rent!  They’re anything from 6-12 x rent typically subject to location, property quality and tenant type.  Super-dooper on all those may get you 12 x but I’ve only seen that a couple of times and I’ve also seen 4 and 14 x rent.

THEN DEDUCT 25-30% of that figure, subject to what bills are included and to cover the additional voids, repairs and maintenances that HMOs face.

Housing benefit tenants, properties that haven’t been recently refurbished and bills included will all mean lower multiples and bigger deductions as may comparable evidence of lower valuations or resales in the area.

2. Consider two other factors;

a) total spend ‘value’ – what you bought it for and what you’ve spent on it.

b) bricks and mortar value, this still must be considered.

Your valuation is likely to end up somewhere around the average of these two and the yield value.

Actual Examples

Example Number One

Property purchased for £150,000

Converted to 7 room all en-suite HMO with rear and side double story extensions at a cost of £100,000 including obtaining Sui Generis planning

£250,000 total spend plus SDLT, purchase and finance costs = £300,000

Bricks and mortar value; effectively the same to buy the property and convert it and comparables were £275-£325,000

Commercial/yield valuation – Good location let to students in the Midlands, superior quality of work so given a 9 x multiple, rent £550 per room = £46,200 per annum x 9 less 25% = £312,000

So we have 3 figures:-

£300,000 total spend
£275-325k comparables/bricks and mortar
£312,000 yield/commercial value

Average = £304,000

The property was valued at… £300,000.

Example Number Two

4 bed terrace purchased for £95,000

Converted to 6 room HMO with shared facilities at a cost of £25,000 mostly comprising basic refurbishment work

No planning required

Let to blue collar tenants for £400 per month per room

Total spend £130,000 inc. purchase and finance costs

Bricks and mortar value of around £125-135,000 comparing to refurbished 3 or 4 bed terraces in the area.

The interesting thing here is that the £28,880 annual rent would falsely lull people into believing that this property is potentially worth as much as 10 x that or £280,000! This is simply not the case and no valuer would value the property in this way.

However, if we do look at the commercial/yield value correctly you will be surprised.

This is a low value northern town, the tenants are blue collar as such the yield multiple might be in the region of 6; so taking the annual rent of £28,800 x 6 and less 25% = £129,600! Not quite the £280,000 expected!

So again if we look at all 3 figures:-

Spend £130,000
Bricks & mortar/comparables £125-135,000
Yield/commercial value £130,000

Average £130,000 and the property was in fact valued at… £125,000.

In contradiction to this, there are high value areas such as London, the SE, Oxford, Cambridge etc. where the intrinsic value of the property is significantly higher than yield value ever would be.  In one case the client was insistent to me that I was to place the property with a lender that would value it based upon the yield value.  I kept insisting to him that he would not want this, but he would not listen.  So I demonstrated by way of the numbers:-

London location

6 room HMO rented for £850 a room a month
Yield value even on a 12 x multiple was £550,000
However the bricks and mortar value for the property was well in excess of £850,000!

Now you know why sometimes you don’t want a commercial valuation!

I run these numbers every single day for clients and it is very rare that we get the expected valuation wrong.  We can ultimately put the property into a lender for whatever valuation you want us to but these numbers rarely fail and this is all about setting expectations at the outset, if we get higher great but it’s always best to hope for the best and plan for the worse!

Other Factors Affecting the Value

With regards to works, unless it’s an up and running HMO, you need a serious reality check if you think you can turn a property into a HMO for £10-20k which is what I regularly hear people quote.

If you’re spending this level of money you’re most likely just creating shared accommodation not a HMO. For a decent HMO conversion TO THE CORRECT STANDARDS and REGULATIONS figures upwards of £50k-100k are the norm.

Another factor is the licence; valuers and lenders won’t increase or decrease a valuation solely due to there being a licence or one being absent but it can strengthen the case for a larger HMO where significant works have taken place but it’s a bit borderline on whether it’s enough to not be regarded as a family home.

Planning on the other hand can create a serious uplift in value; especially for Article 4 or Sui Generis.

So in summary, the more work you do, the more changed the property is from a family home and with the addition of planning you will push up the value further.

Getting All Your Money Back Out

I won’t say this never happens but it is rare.

This tends to happen where there is a serious uplift in the value and extensive works have taken place, also where there is some time lag.  I have clients who will buy properties as single lets then after a year or so obtain planning to convert to a HMO, spend upwards of £100k on them and get all their money back out and some.  The time lag from purchase to conversions, planning and the extent and quality of the works all help with this.

For example, a recent deal I arranged finance for; valuation £700k.  Purchase price £462k with around £11k very light touch up.  The product is 75% so the loan should be £525k yes?  No!

Here are the lenders actual comments:-

“£462k + £11.6k thereby £47,360 to be left in the transaction as commitment.  This would equate to a maximum loan of £426,240.”

As you can see the rent, actual valuation and LTV are secondary.

This can work in your favour if you understand it.  I’ve had a case accepted recently where the client doesn’t fit criteria but instantly telling the lender they’ll be leaving in 10% after all said and done shows them you understand how ‘it’ works.

In summary, with a decent conversion if you aim for leaving in 10% of your total spend you won’t be far off.

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Lisa Orme is an experienced property developer, investor and mortgage broker and specialises in property finance for property investors and developers.

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