The same HMO can carry two defensible valuations at the same time, and the gap between them can run to six figures.
One is what the building would fetch as a house. The other is what its income stream is worth to an investor.
Which one a lender’s valuer applies decides whether your plan to refinance works, and most buyers only find out which basis they are getting after they have paid for the survey.
In short
- An HMO can be valued as a house or on its income, and the gap between the two can run to six figures.
- For small HMOs the default is bricks and mortar, valued against house sales, however strong the rent roll looks.
- Scale, restricted supply and local investment sales evidence together support a commercial valuation.
- On bills-included stock, standardised deductions of a third or more of gross income are common before the yield is applied.
- Ask a lender, through a broker, how it will value the property before you apply, and give the valuer the evidence.
In this guide: 7 sections
This guide explains both bases, what pushes a property from one to the other, and how to avoid underwriting a deal on a valuation you will never be given.
Two bases, two honest numbers
Valuers working to RICS guidance on buy-to-let and HMO property use two approaches. Neither number is wrong. They answer different questions.
Bricks and mortar basis
The bricks and mortar basis values the building by comparison with local sales of similar houses, with the HMO use largely ignored. The bricks figure answers what the asset is worth if the HMO use ends.
Commercial investment basis
The commercial investment basis values the income: net operating income capitalised at a yield taken from sales of comparable investment stock. The investment figure answers what the trading income is worth to the market that buys income.
As an illustration, using assumed figures rather than a real deal or market evidence, here is how far apart the two can sit. Take a hypothetical six-bed HMO with rooms let at £600 a month, £43,200 a year, on a street where comparable houses sell for £250,000. Deduct a third for running costs and net income is £28,800. Capitalised at an 8% yield, that is £360,000, which is £110,000 above the bricks and mortar figure.
The expensive mistake is paying an income price for a building that will be valued as bricks.
Bricks and mortar is the default
For small HMOs the default is bricks and mortar. A six-bed converted terrace that could revert to a family home with little work is, to most valuers and most lenders, a house with a business in it rather than a business premises. Its value sits close to the house next door, however strong the rent roll looks.
That default is not valuer conservatism for its own sake. It reflects the exit: if the widest market for the asset is families and standard landlords, comparable house sales are the honest evidence base.
The consequence for buyers is blunt. A gross yield calculated on the purchase price tells you nothing about what a refinancing will return eighteen months later.
What supports a commercial valuation
Three features move an HMO towards an investment valuation, and they usually need to arrive together.
- Scale and planning status: larger HMOs, particularly those in sui generis use, are not realistically reversible to single dwellings, so house comparables stop being the right evidence.
- Restricted supply: where an Article 4 direction has removed the right to create new small HMOs, existing consented HMOs trade as a constrained asset class with their own market.
- And evidence: actual sales of tenanted HMO investments in the area, because a valuer cannot capitalise income at a yield the local market has never demonstrated.
Heavy adaptation helps at the margin. En suite rooms throughout, fire engineering and commercial kitchens make reversion costly and signal a purpose-built trading asset. None of it guarantees the basis, because the basis is always the valuer’s judgement on the evidence in front of them.
How the income method works
Where the investment basis applies, the arithmetic is unforgiving. The valuer starts from gross income, then deducts standardised running costs whether or not you incur them: management, voids, utilities where bills are included, maintenance and compliance.
On bills-included stock, operating cost deductions of a third or more of gross are common in HMO lending practice, though RICS guidance deliberately declines to fix a percentage and leaves the amount to the evidence in front of the valuer.
The resulting net figure is capitalised at a yield drawn from investment sales evidence, and that yield moves sharply with geography: the rate applied in a northern ex-industrial town is several points above the rate applied in a prime southern city.
This is why down-valuations happen. An investor models 12% gross and mentally capitalises it. The valuer models net income after standard deductions and applies the yield the evidence supports.
Both are consistent methods. Only one of them is the number the lender will use.
C4, sui generis and Article 4
Planning class is the hinge between the bases. Under the Use Classes Order in England, class C4 covers small shared houses of three to six unrelated residents, and HMOs above six residents fall outside the use classes altogether as sui generis.
Movement between a C3 dwellinghouse and C4 is permitted development unless an Article 4 direction has removed that right locally, a mechanism we cover in detail in our Article 4 and HMO investing guide.
Licensing is a separate question from planning class. In England, mandatory HMO licensing applies at five or more occupants living in two or more households, regardless of storeys or planning class. Holding a licence says nothing about planning status or valuation basis.
Planning, licensing and the valuation basis run in parallel, and our guide to what happens to the licence when you buy covers licensing.
The refinancing trap in BRRR deals
The BRRR model of buying, refurbishing and refinancing depends entirely on the end valuation. Buy a tired six-bed outside an Article 4 area, spend £60,000 converting every room to en suite, and the plan only recycles your capital if the valuer signs off an income-basis figure.
On a small C4 with no supply restriction, most will not.
You get 75% of a house valuation, and the capital you meant to recycle stays in the deal.
A projected end value on an income basis, in any sales pack, is a projection about a valuer’s future judgement, not a fact about the building.
Test every claimed end value by asking which basis it assumes and what local investment sales evidence supports it.
Agree the basis before you apply
The basis question is answerable in advance. Brokers can put the property in front of a lender with the tenancy schedule, planning position and income evidence, and ask how it will be valued before any application is made.
Specialist HMO lenders can say whether their panel values on an investment basis for that stock, and what evidence pack the valuer should receive.
Give the valuer the file:
- Tenancy agreements
- Twelve months of income
- Compliance certificates
- The planning position
- Any local HMO investment sales you know of
Valuers work from evidence, and an undocumented HMO defaults to bricks.
What this means for property investors
Underwrite every HMO purchase twice.
Run the deal at the bricks and mortar value with the income treated as a bonus, then run it at the investment value with the deductions a valuer would apply.
Buy when the deal survives the first test, and treat the second as upside rather than the plan.
Do not pay an income multiple for a small C4 outside Article 4, and do not assume a licence or a rent roll changes the basis, because neither does.
On stock where the investment basis is realistic, the evidence pack is your responsibility, so build it during due diligence rather than after the down-valuation.
Check the planning class and Article 4 status on any HMO on our books before you value it, because those two facts drive the number a lender will accept.
This is general information, not advice on your position, so take independent advice before acting.
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