The policy, which was introduced last year by housing minister Grant Shapps, means that planning permission is no longer needed to turn single houses into HMOs.
It was challenged at the High Court in April, by councils from Milton Keynes, Oxford and Newcastle, which complained that they had not been properly consulted about the new regulations.
The authorities claimed that HMOs cause difficulties for residents, including extra traffic, and increased crime and anti-social behaviour.
Their claim was rejected by Judge Sir Michael Harrison, who said there was no unfairness to the councils in the consultation process, as it came just a year after a wider consultation on HMOs by the previous government.
Milton Keynes Council, with the backing of a number of councils across the country, today took their fight to the Appeal Court, in a fresh bid to have the policy overturned.
Lawyers for the council told the court that the authority and local residents have suffered problems caused by HMOs for many years, including increased littering and anti-social behaviour.
Timothy Mould QC said Milton Keynes had the support of councils "up and down the country" in bringing the challenge against communities secretary, Eric Pickles, whose office approved the policy.
The barrister said the support was from "urban" councils, including Leeds, Charnwood, Nottingham, Bristol and Torbay, rather than from rural areas - where HMOs are not as big an issue.
The court heard that, following a consultation in 2009 - in which every council was involved - the Labour government introduced regulations which meant planning permission was needed to convert houses into HMOs.
However, when the coalition government was formed, it was decided the policy should be reversed, in a bid to prevent would-be landlords being put off by the red tape involved in converting a house into flats or bedsits.
Mould said: "The government apparently formed the view that the legislation introduced in 2009 was an unjustifiable burden on those areas where HMO development was not a concern.
"It considered that the legislation deterred prospective landlords from entering the market and endangered low-cost housing in many areas."
There was a second consultation in June last year, but councils were only represented collectively by the Local Government Association, and were not asked directly for their views.
Mould told the court that the regulations were then changed so that planning permission wasn't needed to create HMOs - despite the fact this was the least popular option in the 2009 consultation, with just one per cent of the responses supporting it.
Milton Keynes Council contends that the exclusion of local councils from last year's consultation was "unfair and unreasonable".
The Appeal Court heard the council has in fact changed its own planning policy - so that permission from the authority is needed to convert a house into an HMO - but still faces the prospect of having to pay out compensation to landlords under the new regulations.
Lord Justice Pill, Lady Justice Arden and Lord Justice Macfarlane are expected to reserve giving their judgment on the case until a later date.