HMO Development Finance

Investing in HMO properties can be very lucrative, enabling you to benefit from higher rental yields than standard buy-to-let properties. Depending on the type of project you want to undertake, there are different financing options to choose from. If you plan to embark on a large-scale project, then HMO development finance is an ideal solution. This is perfectly suited to a conversion, a ground-up development or a large-scale renovation.

As the UK’s specialist mortgage broker for investors and developers, we have extensive knowledge and hands-on experience with HMO projects. We understand the intricacies of each project undertaken, the different circumstances and loan requirements from borrowers and the complex nature of HMOs. We strive to simplify the complexities and take a personal approach to your application, ensuring that it is optimised to secure the funding you need for your investment project. We work closely with specialist HMO lenders who offer tailored solutions, no matter how extensive or complex your development project may be.

In this guide, we explain how HMO development finance works, the types of finance available and the types of HMO projects you can use this finance for. We also cover the eligibility criteria, costs involved and repayment strategies.

Key points

• HMO development finance is a short-term funding solution for large or complex projects. It supports conversions, ground-up builds and major refurbishments or renovations, with funds that are released in stages to help you stay on schedule and within budget.
• Lenders focus heavily on experience, project viability and a strong exit strategy. Your previous experience with HMOs or development projects, the location and layout of the HMO, the necessary planning permission, the robustness of your schedule of works and the strength of your exit strategy all influence your eligibility for a loan and the amount you can borrow.
• This type of finance offers flexibility but comes with higher costs and detailed requirements. Rolled-up interest, staged drawdowns and no early repayment charges improve your cash flow. However, you need to factor in valuation fees, monitoring costs and contingency funds. You also need to provide comprehensive documentation, including professional reports, planning consent, a full schedule of works and evidence of your exit strategy.

A house in multiple occupation (HMO) is a property that’s specifically designed to be rented out to three or more tenants who are from different households and use shared facilities, such as a kitchen, bathroom or toilet. With an HMO property, each tenant pays rent rather than one rental amount being charged for the entire property, as with standard rental properties. As a landlord, this allows you to maximise the returns on your investment.

Examples of HMO tenancies include a group of working professionals living together or a group of students sharing the same accommodation. Each tenant has their own bedroom but shares the common facilities.

HMO development finance is a short-term loan that’s usually taken out for up to 24 months. It’s designed for large-scale projects, such as converting a property to an HMO, building an HMO property from scratch or carrying out major refurbishment works. For example, you may want to change the use of a commercial property to shared HMO accommodation. Or you may wish to convert a small residential property into a large HMO.

This type of finance allows you to fund the entire project, such as purchasing the land and/or property and the development costs. The loan is typically secured against the property that’s to be developed; however, an alternative property or site can be used if necessary.

Unlike an HMO mortgage or a bridging loan, the funds for an HMO development finance loan aren’t all released upfront. If you’re purchasing a property or land, the funds needed for that purpose are released in advance. After that, the funds are released in stages during the development project. This helps to ensure that you stay within budget and on track with your project. These stages are pre-agreed with your lender. As development projects can often experience issues, lenders are usually willing to change these stages if need be to accommodate your project. For example, you may fall behind schedule or an unexpected issue may occur that requires extra funding.

Lenders vary in how much they’re prepared to offer for an HMO development finance loan. Generally, you can borrow up to 75% of the property or site value and up to 100% of the development costs.

Who can apply

You can apply for HMO development finance as an individual or a company, such as a limited liability partnership (LLP) or a limited company. Lenders accept new and existing companies. Generally, lenders prefer you to have experience with HMO properties and/or development projects. However, don’t be put off if you’re new to both as first-time developers are also considered by some lenders.

The interest payments

The interest charged on your HMO development finance loan is calculated on a monthly basis and is usually rolled up. This means that it’s added to the loan amount and repaid at the same time as your loan. With this option, you don’t have to worry about making monthly interest payments, helping to improve your cash flow. If you prefer, a retained interest option means that the lender will calculate how much interest will be owed over the loan term and then retain that amount from the advance.

Repaying your loan

The loan is repaid at the end of the term and your lender needs details of your exit strategy at the time of application. This can be to refinance the newly developed HMO property to an HMO mortgage so that you can rent it out, for example. Or you can sell the developed property, repaying the loan from the sale proceeds and benefitting from a profit on your investment. You may even be able to use the rental income from your HMO property to repay the loan, depending on the lender. Usually, there is no early repayment charge if you finish your project ahead of schedule and repay the loan early.

There are various key features that make HMO development finance an ideal funding solution, as detailed below.

• Flexible: Tailored solutions can be provided for numerous types and scales of developments. This includes residential and commercial properties, single dwellings to blocks of flats, conversions, refurbishments and large-scale renovations. If your project encounters delays or unforeseen issues, the lender may be willing to adjust your payment stages.
• Funding is released in stages: The funds are released to you at pre-agreed stages of your project. This helps you to keep on track with your project and stay within your budget.
• Improved cash flow: The interest is usually rolled up and payable once your project has been completed. This helps with your monthly cash flow management.
• Interest is based on a monthly or daily rate: The interest is calculated on what you’ve drawn from the loan rather than the entire loan facility. This helps to minimise your costs over the lifetime of the project.
• No early repayment charge: Lenders don’t usually charge penalty fees if you finish your project early and repay the loan before it’s due.
• Accessible: You can secure a loan as an individual or in a company name. Lenders prefer you to be experienced in dealing with HMO properties and/or developments but you can still secure a loan as a first-time developer. 
• Swift lending decision: As experts in this field, we have formed strong relationships with lenders. This ensures that a quick decision can be made and you benefit from a swift in-principle offer.

There are numerous types of HMO developments to consider investing in. Examples of these can include:

• Converting the use of a standard residential property to an HMO property
• Building an HMO property from scratch, including buying the plot of land to build it on
• Carrying out structural upgrades
• Renovating an uninhabitable property
• Refurbishing a property
• Converting a commercial property into shared accommodation
• Extending a property and then converting it into an HMO

When assessing your application, lenders take various factors into account, which we’ve explained below.

Your experience

Lenders prefer you to have experience as a landlord, usually for a minimum of 12 months, and preferably as an HMO landlord. They also favour borrowers with development experience, although first-time developers are accepted. If you’re new to this type of project, you’ll need to show the lender that you’ve appointed a team of professionals to handle the development.

The development’s location

The success of an HMO largely depends on its location. You need to choose a good location for the type of tenants, such as near a university when offering student accommodation or close to transport links for professionals. Find an area where demand outweighs the supply and the potential rental yields are high. You don’t want to choose a location that’s already saturated with HMOs or where there’s no consistency for rental demand.

Property size

Some lenders specify the size of property that they will offer a loan for. For example, a minimum of 3 bedrooms or a maximum of 8 bedrooms.

Property layout

A standard room layout is preferred because the layout can affect your property’s compliance as well as your legal obligations as a landlord. The requirements for this can vary depending on the size of the property and the local authority’s stipulations.

Comparables

Comparables of similar HMO developments in the local area determine the value of your development project. This, in turn, affects your borrowing potential and overall eligibility for a loan.

Loan size

The amount you need to borrow and how much you can pay as a deposit are taken into account. Generally, you need to put down a minimum deposit of 25% or 30%. If you’re a new developer, you may be required to pay a higher amount, such as 40%.

Clear and robust business plan

You need to provide a detailed schedule of the works to be carried out. This must include the development phases and costs as well as evidence of the gross development value (GDV).

Planning permission

The lender needs to see proof that you have obtained the necessary planning permission or evidence of permitted development rights.

Creditworthiness

A credit check will be carried out by the lender to check your financial profile. Having a good credit history is preferred, although we work with specialist lenders who offer loans to borrowers with adverse credit.

Exit strategy

Having a strong exit strategy is crucial to being approved for a development finance loan and the lender will test its feasibility. We ensure that you have a credible exit plan in place to strengthen your application and help secure better terms for your loan.

HMO licence

It’s essential to check that your property meets the HMO licensing requirements. This is determined by your property’s location and size as well as the local council’s requirements.

The amount you can borrow typically depends on the gross development value (GDV). This is the projected value of your finished development project rather than its current value. Usually, you can borrow up to 70% of the GDV as an experienced developer. This means that if your project has a GDV of £500,000, you can expect to borrow up to £350,000. If you’re a new developer, you can generally borrow up to 60% of the GDV. Using the GDV example of £500,000, this means that you can expect to borrow up to £300,000.

The amount a lender agrees to offer you is determined by other factors, too. These include the type of development project you require funding for, the location of the development, your level of experience and the strength of your exit strategy. Our development finance brokers can assess how much you can borrow according to different lenders’ criteria and compare the loan terms they’re offering. This enables you to make the best decision according to your project’s needs.

When applying for development finance, there are various fees to factor into the costs as well as the interest that’s payable. How much you have to pay for these is determined by the amount you want to borrow, the term that you want to take the loan out for, your development experience and the percentage of overall costs borrowed.

Interest

HMO development projects are complex and come with a higher level of risk for lenders. This is reflected in the interest rate charged on a development finance loan, which tends to be higher than for other types of funding. That’s not to say that you can’t benefit from a competitive interest rate, especially if you’re an experienced developer.

Unlike long-term finance, such as a mortgage, the interest rate isn’t such an important concern for this short-term loan. You may be offered a low interest rate but have to pay high fees for a particular deal, for example. As such, you need to weigh up the total costs carefully and our brokers will go through these with you.

For an HMO development finance loan, the interest is usually rolled up. This means that it’s repaid when you repay your loan, saving you from having to make monthly payments. Also, interest is typically only paid on the funds you use from the drawdown facility. This means that interest isn’t payable on any unused funds that are still held in the facility, minimising your costs.

If you decide to refinance to a longer-term loan, such as an HMO mortgage, once your project has been completed, you can expect to pay a lower interest rate.

Fees

There are various fees to factor into your costs, which differ depending on your project. These can include:

• An arrangement or facility fee. This fee, which tends to be between 1% and 3% of the total loan amount, is charged by the lender for setting up the loan facility. It’s generally added to the loan amount.
• Valuation fees. A valuation must be carried out before your project starts to ascertain the site’s current value. When your project has been completed, a further valuation has to be done to confirm the GDV.
• Monitoring surveyor costs. A monitoring surveyor is usually appointed by the lender to oversee your development project, providing them with progress reports. These reports confirm whether your project is on track for the schedule of works and build costs and that any building regulations are met.
• Legal costs. These include your own solicitor’s fee and, more likely than not, your lender’s legal costs.
• Other professional costs. You’ll need to use the services of various professionals on your project’s team, such as a project manager, an architect and the builders. Their costs also need to be taken into account.
• Drawdown fees. Each time some funds are released to you from the loan facility, a fee is charged.
• Non-utilisation fees. Depending on the lender, you may be charged these fees for funds that have been made available to you in the loan facility but that you haven’t yet used.
• An exit fee. If applicable, this may be charged at about 1% of the GDV or the total loan amount.

A contingency fund is also required in case any unforeseen issues occur. A recommended amount is typically 10% to 20% of the total project costs.

Rather than making monthly repayments, such as with a mortgage, an HMO development finance loan is repaid in full at the end of the term. This helps you to manage your cash flow during your project and removes the pressure of having to find the funds needed to make repayments. From the lender’s point of view, it reduces the risk of you running out of funds during the project, which would jeopardise its completion.

This arrangement, therefore, means that you need a strong exit strategy, which is how you intend to repay the loan. Your lender needs to see evidence of this before approving your application. The three main exit strategies are to:

• Refinance to a long-term loan, such as an HMO mortgage
• Sell the HMO development and repay the loan from the proceeds
• Use equity release from another asset or project

If you have chosen to sell the development after completion, you need to provide the lender with evidence of the expected sale price. This can be obtained using comparables or from appraisals by estate agents. If you refinance to a mortgage, you can benefit from a lower interest rate than the one payable for your development finance loan.

Whichever exit strategy you choose, the lender will test its feasibility. This can be done by stress-testing the rental yields, mortgage availability or sales prices. Before submitting your application, our HMO development finance experts will ensure that your exit strategy is robust and well-documented. This will not only help to strengthen your application but will also enable you to secure better loan terms.

No matter how well you plan, development projects can and do go wrong. Unexpected delays can occur, such as waiting longer than expected for planning permission to be granted or experiencing construction issues during the project. The market may take a turn for the worse by the time your project is completed, making it impossible to achieve the sales price or rental figure you had originally expected. Whatever your reason for being unable to repay your loan when it’s due, there are a few options to consider.

Ask your lender for an extension

Some lenders are willing to grant extensions depending on their policies, the loan terms and your project’s status, with some offering more flexibility than others. If your project has fallen behind schedule but you have a clear plan, can show that the delay was caused by unforeseen issues and can provide evidence that the project is still profitable, the lender will be more likely to agree to an extension. Bear in mind there will be additional costs to consider, such as fees and extra interest payments.

Refinance to development exit finance

This option gives you the flexibility needed when your repayment deadline is near and either your project remains unfinished or you’ve been unable to raise adequate funds from your completed project. Development exit finance is a short-term loan, which enables you to have more time to finish your project or to sell your development. With a lower interest rate than your original loan, it helps to reduce your costs and maximise your profits. You can also release some of the capital from your development before finalising a sale, enabling you to fund your next project in the meantime.

Use additional capital

If you have personal funds, these can be used as a contingency plan to finish your project or make up the repayment shortfall for a completed project. Another option if your project has run over time is to ask the lender if they’ll consider a small top-up loan.

Having a strong application improves your chances of successful loan approval, with fast acceptance and better terms. For this, you need to gather all of the necessary documentation, including:

• Your personal ID
• Company documents, if relevant
• Evidence of planning permission or permitted development rights
• Professional reports
• Project appraisals
• A detailed schedule of works
• Evidence relating to your exit strategy

You need to convince the lender of the credibility of the plan, providing them with a detailed budget for the costs, your contingency plan, the development appraisal and the anticipated return on your project. Working with a professional team reduces the risk for the letter so provide details of who’s involved with the project, such as an architect and a project manager. As mentioned earlier, you must also have a strong exit strategy with clear evidence to back this up.

Our team is here to ensure that your application is optimised before being submitted to the lender. We can help you prepare the necessary documentation and present it in the best light. That way, you can look forward to a quick decision and favourable terms for your project.

If you’ve got an HMO project in mind that requires significant work, development finance may be the ideal funding solution for you. For example, you may be ready to invest in a multi-unit development, convert the use of a property, carry out extensive renovation or refurbishment works or build an HMO property from the ground up. This type of finance can be provided on any scale, from a smaller scheme to a larger development, and arranged in a bespoke manner to meet your project’s needs.

If you’re a first-time developer, you can still secure this type of funding. You need to show the lender that you have a professional team ready to work on the project and provide evidence of the project’s feasibility. A clear exit strategy is crucial and you also need a contingency fund in place. This is usually 10% to 20% of the total project costs. At Trinity Finance, we regularly work with new developers so you can rest assured that your application will be correctly structured and optimised to secure the funding you need.

An HMO development project can be very lucrative, resulting in much higher returns than a standard property rental. With the right area and type of property, you can also rely on consistent lets due to high demand from tenants looking for good quality, affordable accommodation.

Our development finance experts are here to help you secure the funding you need, whether you’re applying in your name or a company name, are new to development projects or are an experienced developer and whether you’re embarking on a small project or a large-scale one. As every project is unique, your application will be tailored and the best lender approached to suit your situation and requirements.

To discuss your project with one of our development finance experts, give us a call on 01322 907 000. If you prefer, send an email to us at info@trinityfinance.co.uk or an enquiry via our contact form. We’ll reply to you as quickly as possible with more information. With the right funding in place, no matter how complex your project or situation, you can look forward to turning your HMO plans into reality and reaping the rewards.