Renting room by room: your path to power profits?

By

22/11/2011


Conventional property investment wisdom suggests that you rent one property on one lease – whether that’s signed by one person, a couple, a family or flatmates. However, that’s not the only way to let out your investment: what about letting a property room by room? 

It’s a well-established strategy, especially in the context of boarding houses, student accommodation and backpacker hostels. Admittedly, it involves more work and can be more costly than the more familiar type of investment, but the benefits can also be significant – not least rental yields in double figures as well as solid capital growth for the right properties. 

So, do those financial benefits outweigh the extra hassles that come with renting a property room by room? 

The legal situation

There are a few legal considerations that any investor planning to let rooms separately needs to bear in mind, says Wroth Wall, property lawyer and principal at Wall & Company. 

“The first consideration that investors need to bear in mind is whether the occupants of the property will be classed as lodgers, boarders or tenants: each confers different rights on the resident, and can leave you liable to very different laws,” explains Wall. 

Landlords are most likely to fall foul of the distinction between tenants and boarders. In short, tenants are granted exclusive use of a property or part of a property, and have the most rights. Boarders have fewer rights – however, landlords typically have to provide certain services, such as food, laundry and so on. 

Wall emphasises that you should be clear who your clientele is likely to be – students, backpackers, long-term residents and so on – and which side of the divide you wish to fall on. Otherwise, you might find that yourself unintentionally in a lease situation, or that you are liable to provide additional services that you may not have anticipated. 

It’s also important to check local council planning laws and regulations regarding multi-occupancy houses, as these vary not only from state to state but from council to council. 

For example, in the greater Sydney metropolitan area, the SEPP 10 (State Environmental Planning Policy) regulation places restrictions on the development of low-cost rental accommodation – particularly boarding houses and hostels – which could impact the feasibility of an investment. Other councils require there to be a property manager on site at all times, and there are often requirements for minimum numbers of smoke alarms, fire exit signposting, multiple exits and other health and safety requirements – all of which could add to your establishment and running costs. 

Other hurdles

Over and above the legal considerations, there are also a number of practical issues that investors need to bear in mind – not least the fact that multi-occupancy properties will require a lot more work than a ‘normal’ investment. 

                Financing

Lenders are, to put it lightly, ‘somewhat twitchy’ about boarding house-style properties. Jane Slack Smith, Director of Investors Choice Mortgage and founder of Your Property Success, says that the hesitancy largely revolves around what happens if you have to sell up. 

“Lenders’ objections are typically to do with onselling: as a rule, it’s generally only investors who are interested in buying properties like this, so you’ve got a smaller pool of potential buyers to begin with,” she says. “Lenders are also wary of the situation regarding vacancies, as you tend to see more short-term and student tenants, which can lead to a higher vacancy rate.” 

Amit Sharma, a Melbourne-based mortgage broker with LoanMarket, agrees, but highlights that the type of property can make a difference. 

“If you’re talking about a property that has been purpose-built for multiple residents, then lenders will typically see it as a commercial proposition, and therefore will only lend on commercial terms – which means a higher interest rate and a larger deposit.” 

Properties that have been converted from existing homes are a different matter, in his experience. 

“Residential property with lots of rooms tend to be evaluated on a case-by-case basis, depending on whether the property can be resold as a family home,” adds Sharma. “Similarly, with smaller properties – say three- or four-bedroom houses – it again hinges on who the property could potentially be sold onto.”           

Even so, Slack-Smith warns that even something as simple as having locks on internal doors can set lenders’ alarm bells ringing – even if you’re not planning on running a multi-occupancy property – and could derail your plans for finance. You should also notify your lender if you’re considering converting an existing property, otherwise you could be going against the terms of your loan contract. 

                Property management

The next significant hurdle is property management. Many property managers will simply refuse to deal with multiple occupancy properties, and those that do charge a hefty fee – as much as 12%. 

As a result, many landlords who operate multiple occupancy properties end up managing the properties themselves. This brings with it all the downsides that come with DIY property management, such as having to source and interview tenants, deal with day-to-day tenant management, and implement rent increases. 

Due to the nature of this type of property, the downsides of directly managing a property can be magnified – after all, you may have to negotiate several rental increases over the course of a year, rather than just one. Another issue, too, is the fact you’ll be dealing with several tenants who may not otherwise have chosen to be living in the same space. 

“There can quite often be conflicts of personality, as your various tenants aren’t necessarily choosing to live together and might not get on,” says Slack-Smith. “Is that something that you, as a landlord, really want to be involved in?” 

Sharma firmly recommends paying the premium for a good property manager if possible, as it can also ease lenders’ jitters over multi-occupancy properties. 

“It’s much easier to show the rental income if you use a manager, as it’ll all be contained on one rental statement ,” he comments. “If the property is self-managed it can look confusing with multiple rental payments coming in based on multiple leases – and that can be problematic with lenders. By using a property manager who can present the income clearly on a single statement, you can improve your financing options.” 

For landlords that are directly managing the property, there is another popular option to ease the burden, adds Sharma. 

“One of my clients has appointed one tenant as the ‘caretaker’ of the property: they look after the shared areas, undertake basic maintenance and sometimes collect rent,” explains Sharma. “In return, they pay $20–30 less in rent per week. It’s a good solution, as it means you’ve got someone on hand in the property to look after the basics – although you’ve still got to deal with the overall property management, and you’ll have to factor slightly lower rental income into your calculations.” 

                Furnishing

The question of whether the property is furnished or unfurnished is one that is more pressing for landlords of multi-occupancy houses. 

Many landlords provide the properties fully furnished, or at least with furniture in shared areas. Increasingly, facilities are also being included in tenants’ private rooms – such as kettles, microwaves and/or small fridges. This means further costs for the investor to kit out the property, as well as consideration as to how furniture and white goods owned by the landlord are dealt with in tenancy agreements and landlord insurance. Indeed, it even can be the case that landlord insurance is difficult to obtain, as some insurers may refuse to insure properties rented out on multiple leases, as real-life investor Jemma Lane found out (see ‘Real life story’). 

Providing a property fully-furnished can also encourage short-term tenants, rather than tenants planning to stay for the long term; on the plus side, it does allow you to charge a higher rent. Slack-Smith argues that it’s a trade-off between seeking longer-term residents but with a lower income, and a higher cash income but a likely higher turnover of tenants. 

Working the numbers

However, assuming you can deal with the various idiosyncrasies of running such a property – and finance it – the financial benefits can be significant. Sharma reckons that running a property as multiple occupancy can increase the gross rental yield from 3–5% to 10–15%, and that you can still see yields of 7–12% even when the higher running costs are taken into the equation. 

“You effectively can do multi-let anywhere,” says Sharma. “Depending on location, you’ll attract a different type of tenant – so, if you’re near a university, you’ll most probably get students, whereas if you’re near the inner city you’ll get a higher proportion of single professionals. I’ve got one tenant who specialises in multi-occupancy properties in regional mining towns, providing accommodation to workers. He’s seeing gross yields of 15-18% in some of his properties.” 

Most multiple occupancy properties experience similar capital growth as more traditional properties, too: that is, as long as they have scope to be converted back into more traditional accommodation. 

“In my experience, converted multiple occupancy properties are very rarely distinguished in terms of growth,” adds Sharma. “Admittedly, they may only be of interest to homeowners if they’re specifically looking for a large family home, but it tends to be the case that most existing multi-let properties are marketed to all on the grounds that they’re easy to turn back into a family home 

“Purpose-built properties are a different matter, as they typically will only be bought by investors: therefore, you tend to find that the value is directly tied to the rental yields,” he says. 

Slack-Smith’s advice to investors considering a multi-occupancy property is to be wary. 

“My initial reaction when anyone mentions these type of properties is usually ‘Beware! Beware!” she says. “You really do have to thoroughly work out the risks as well as the benefits. 

“Bear in mind things like the extra expenses, the faster wear and tear, the possible higher vacancy rates, the financing issues; you need to balance that out against the potential gains to ensure its worthwhile,” continues Slack-Smith. “It’s easy to be attracted by these types of properties because of the large yields, but you can’t be blinded by the profits alone. You need to realise they’re a very hands-on investment – and definitely not ‘set and forget’.” 

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Comments
  • ROSANNA CUMMINS says on 06/05/2014 09:48:06 PM

    How do I get to read the real life story of Jemma Lane mentioned in the article by Ashley Fallon on multiple room letting and getting insurance?

  • matt says on 03/09/2014 05:31:05 PM

    Multiple occupancy dwellings - especially more than one occupant per room - are an increasing problem in Australia and it HAS to stop. Why?

    (1) It drives up rents.
    (2) It rips people off (most are foreigners often paying the same amount to share a room that they might pay for a room of their own)
    (3) Its a burden on local services and a pain to neighbours. (6 people in a 2 b/r flat next door gets pretty old pretty quickly - as do the overflowing bins!)
    (4) There are safety issues too. In most EU countries, these places need to be registered as 'rooming houses', need fire doors and locks on every room, extinguishers etc and a lot of insurance.

    I'm keen to start a campaign against this blight on our already moronically overpriced rental market.
    Who's with me? :-)

  • Richard says on 15/01/2016 08:44:44 AM

    Matt,

    I'm NOT with you because there is a genuine need for this style of accommodation in Australia.

    As of the last census date there were 105,237 people experiencing homelessness.

    Just wondering please, how would you suggest we solve that problem?

    Best Regards

    Richard

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