Photo by WJF Developments
Even if you feel you don’t need finance for your HMO right now, it’s still a good idea to start working on this, and learning how to recycle capital can help you regenerate cash and fund your property investments.
You never know when you’ll need additional funding or how quickly you’ll need it if the perfect deal pops up. Getting your hands on the amount of funding you need can be particularly challenging, especially with how capital-intensive investing in HMOs is.
In this guide, we’ll discuss the benefits of recycling capital, how you can do this in your own HMO portfolio and some of my top tips!
The Benefits of Recycling Capital
To grow your HMO business, you’ll need to access working capital. The amount you’ll need for each project will depend on your investment strategy, the kind of property you’re looking to purchase and the end product you’re wanting to create.
Recycling capital is a great addition to any funding strategy to help you get your hands on more capital you can then put back into your business. If you’re looking to really grow your HMO portfolio, the more capital you can get your hands on, the faster you’ll be able to grow. You’ll then be able to purchase more deals, undertake additional refurbishments and invest in more infrastructure within your business.
If I started my property businesses over from scratch, I would prioritise adding value and recycling that out of my projects, especially at the beginning. If you can master this, along with the other main ways to fund your properties and renovations, the ability to scale your HMO portfolio will be infinite!
While property values tend to go up over time in the UK, you shouldn’t solely rely on capital appreciation when it comes to this. However, this can still provide opportunities to extract value, recycle capital and scale your property business.
Naturally as an investor, you will need to be comfortable with taking financial risks. It’s just part and parcel of any type of property investment. And investing in HMOs is especially capital intensive, so there will be additional risks that come with this.
When getting your portfolio off the ground, you’ll typically have to do the next deal before getting out of the last, and your income will quickly get sucked back into your business. There’s a lot of financial pressure when it comes to this, and it’s money you don’t have in your bank account on a day-to-day basis. So, you need to find solutions to allow you to keep adding value and recycling capital.
Additionally, it’s essential to understand the other ways you can finance and fund your HMO portfolio, including utilising mortgages and raising private finance. If you can tap into all of the different avenues for funding your HMOs and refurbs, financing your deals will no longer be an issue!
On top of that, this will help you build the foundations to be able to purchase the right properties when they crop up, ensuring you won’t miss out on good HMO deals and allowing you to grow your portfolio.
Start considering how you can recycle funds from your HMO deals. Recycling capital is essential for a business that needs to regenerate cash. This should be a key priority as it can even support private finance deal structuring so you can then crucially pay investors back!
Understanding How to Recycle Capital
There are a few key considerations when it comes to recycling capital. You really need to do your research and due diligence when it comes to effectively doing this time and time again on your HMO projects. Here are some of the main things to do, understand and keep in mind!
1. Find Properties With Opportunities to Add Value
Adding value is one of the fundamental strategies for building a sustainable HMO portfolio. The idea is that you look for properties that you can improve or add to, and in doing so, increase its net value. By adding to the value of property, it allows you to stretch your capital further.
If you know your investment location well and what a good HMO deal looks like, while avoiding making emotional decisions and sticking to what you know, then you’ll likely be able to find good opportunities to recycle capital. You might have to buy in peripheral areas or smaller towns, which are typically more affordable areas to buy, to be able to really add value.
Look for properties where there are opportunities to add square footage through extensions and garage and loft conversions. Also consider properties where you can add aesthetic value. Bathrooms and kitchens are typically where you can do this.
Often big boxy floor plans can be helpful, and don’t be afraid of buying ugly properties. There can be loads of potential if there’s a good floor plan and the property is in a good location. That often means prices are better, so you can add more value and recycle capital out of the deals, allowing you to be more profitable!
2. Search for Properties Below Market Value
Given the choice, no one would willingly sell below market value (BMV), but there are a number of situations and circumstances that could leave a property owner with little to no choice to sell below market value. This could be because they may need cash quickly for whatever reason.
Some people assume that the asking price of a property is also the value of the property, but that’s not always the case. These are different things with the market value being determined by specialists and data, and the asking price is determined by what a seller thinks their property is worth or what they want for it.
There are a few places and ways you can find BMV deals. This can be done on the open market through property portals like Zoopla and Rightmove, but a good portion of distressed asset sales happen at property auctions and off market transactions through networking contacts or direct to vendor marketing.
If you want to prioritise securing BMV deals, work on finding motivated sellers, build relationships with agents and pipeline deals. With these sorts of purchases, be ready to move quickly as this can further help you negotiate a reduction in price. However, this is not to say that you shouldn’t buy any properties at full or even above market value, especially if a property and all of its characteristics fit your long-term strategy!
3. Figure Out How to Genuinely Add Value
There are additional ways to add value besides extending a property or converting a loft or garage, which can also boost your income. Undertaking a quality refurbishment without spending too much and dealing with structural or legal issues can also allow you to add genuine value.
Additionally, you can change the floorplan to make the best use of the space or give it some kerb appeal, which can be a very cost-effective way to add value. The opportunity to add value to a property is almost always available as long as you didn’t overpay for the property, but keep in mind that every location has a limitation on what the upper value can be.
4. Nail Your Numbers
Knowing your numbers in and out and getting them right is an essential aspect of any funding strategy! Start by perfecting your deal analysis. You need to thoroughly understand what your HMO deals and properties should look like, in addition to the maths behind them.
In addition to being able to effectively construct a deal appraisal, you need to also know how to interpret what the numbers mean and make assumptions with a certain degree of accuracy on your costs and average occupancy level.
5. Understand Commercial Valuations
Depending on the number of rooms in your HMOs and the rent rolls those rooms are generating, it may be possible to get a commercial valuation. If you then refinance off the back of that, you may find you’re able to recycle more capital, which you can then roll forwards into your next HMO deal.
Commercial valuations can allow you to release more equity from your HMOs. Through this, a surveyor can at least partially discard the bricks and mortar value of a HMO and use the rental income instead to determine the property value.
When surveyors look at HMO commercial valuations, they’ll take three different valuation methods into account, including local comparisons, the estimated total value of the completed project with all the costs subtracted and calculations that consider the property’s gross and net rental income. They will then use all of the data and experience to then derive a final commercial valuation.
However, you can’t know what the valuation will be until it is valued. Every lender, surveyor, property and location have different considerations. Keep in mind that HMOs with commercial valuations can be an issue when it comes to refinancing or selling if you have any problems with occupancy.
There is a time and place for commercial valuations, particularly when you’re growing, scaling and taking on additional (but manageable risk), but over time you may want to reduce your reliance on commercial valuations.
6. Reinvest Into Your HMO Business
When you recycle capital out, don’t only reinvest that into your next property or paying yourself a wage. Make sure you reinvest into your business as well. This can be done by putting money towards setting up systems and processes and hiring staff, which will help you further scale your HMO portfolio.
While of course we all want to build our property investment business and generate more cash flow where possible, you still need to invest in these areas in order to be able to grow. This will help you continue to work towards building a bigger and bigger business, especially as at some point you won’t be able to do it all on your own!
Funding Your HMO Portfolio
If you’re considering investing in your first or additional HMOs soon, ensure you’re ready for any funding you’ll need to acquire for your projects, including factoring in ways to recycle capital. Understanding how to effectively add value to your HMOs can allow you to get the most out of your properties and refurbs. This will likely be particularly crucial moving forward!
To effectively start, scale and systemise your HMO portfolio, become a member of The HMO Roadmap, where you can access 400+ interactive training videos, useful templates for your business and tools to help you find, fund, fix and fill your properties!
If you’d like to be a part of our supportive community where you can ask any questions you have about HMO investment and gain advice from experienced investors, join us in The HMO Community, our free Facebook Group.
About the Author:
Andy Graham is the founder and the lead trainer at The HMO Roadmap! He writes as a regular columnist in different magazines about a variety of HMO topics and is the host of The HMO Podcast! Follow Andy on Instagram!