Mezzanine finance for HMO and co-living schemes

Houses in multiple occupation and co-living schemes convert space into rooms let individually, which lifts the income per square foot well above a standard tenancy. The demand comes from young professionals and sharers priced out of self-contained flats, and from the flexibility a room-by-room let offers. Schemes range from a six-bed HMO conversion to a purpose-built co-living block with shared amenity, and the return is realised through rental yield and a refinance onto a specialist buy-to-let or investment facility.

The complication is regulation and value. Article 4 directions in many areas remove permitted-development rights and require planning for a change to HMO use, licensing sets room and amenity standards, and valuers can be cautious on the exit value of a large HMO. Senior lenders reflect all of that by lending conservatively against cost. Mezzanine bridges the gap so a developer can complete and stabilise the asset. We look hardest at the planning and licensing position, the room mix and the refinance valuation.

A typical hmo & co-living capital stack

HMO lot sizes are smaller and exit valuations can be conservative, so senior debt is held cautiously and mezzanine bridges to a stabilised let. Illustrative only; every stack is sized case by case.

Why HMO and co-living finance is its own case

Letting a building room by room lifts the yield well above a single tenancy, but it also drags in a layer of regulation that ordinary residential does not carry. An HMO above a certain size needs a licence that sets minimum room sizes, amenity ratios and safety standards, and in many urban areas an Article 4 direction has removed the permitted-development right to change a family home into an HMO, so the conversion needs planning consent. Get either wrong and the scheme is worth far less than the yield alone suggests.

Senior lenders price that uncertainty in and lend cautiously against cost, especially where the exit value of a large HMO is harder for a valuer to pin down. Mezzanine bridges the gap between that conservative senior loan and a thin equity slice, so a developer can fund the conversion or build and hold the asset through to a stabilised, income-producing let.

How mezzanine changes the equity maths

HMO returns are yield-led, and the deals are often smaller than a housing scheme, so tying up 40 percent of cost as equity in one property is an inefficient use of capital for a developer running several. Mezzanine keeps the equity slice thin and lets the same capital fund more rooms across more addresses. The mezzanine leverage calculator shows the effect on the equity return, and our note on mezzanine versus bridging is worth reading, because some HMO conversions suit a first-charge bridge better than a mezzanine layer.

Exit routes we underwrite to

Most HMO and co-living schemes exit through a refinance onto a specialist HMO or co-living buy-to-let facility once the rooms are let and the income is proven. Some developers sell the stabilised asset to an investor who wants the yield. Either way the exit valuation is the pinch point, because a large HMO can be valued on a bricks-and-mortar basis or an investment basis and the two can diverge widely. We stress the exit against a cautious valuation so the refinance clears both senior and mezzanine.

What our underwriting focuses on

• The Article 4 position and whether change-of-use planning is needed
• Licensing: room sizes, amenity ratios and achievable licence category
• The room mix, target tenant and rental demand in the location
• The refinance valuation basis and the specialist lender likely to take it out

Where a first-charge bridge fits better than a mezzanine layer, we can arrange bridging finance whole of market instead, and tell you which is genuinely the better fit for your scheme.