Many new investors in the Single Family Home space prefer acquiring turn key rentals- homes that don’t require any major work prior to renting; this is a safe and foolproof acquisition strategy for steady cash flow. Today I wanted to focus on why purchasing a property that requires some TLC actually makes more financial sense and significantly increases your cash flow.
Before we start though, we need to absolutely clear that this strategy only works if you are able to find a property that needs some work at a significant discount. In the COVID market these deals are hard to come by as property appreciation is seen across the board due to decreased supply. Properties that need significant work put in with a similar discount to the pre- Covid market are hard to come by. But if you can find a good cash flowing property that is discounted as it requires some upgrades, then this is definitely a strategy to consider.
The right time to do a rehab on your rental is right after acquisition, before you put your rental in service. When you do this, you are increasing the value of your property – FORCED APPRECIATION by increasing it’s ARV (After repair value). A lot of savvy investors will tap into this increased equity right away by doing a cash out refinance. Also, with your newly renovated property, hopefully you have increased your monthly rental cash flow; win-win. Let’s dive into an example to look at the numbers…
Scenario: Say you purchased a Single Family rental property for 250,000$ and put 20,000$ into renovations. If the ARV of your property increases to 300,000$ then you have forced appreciation of the property by 30,000$ (300k – 270k)! Now you may choose to leave the increased equity in the property in favor of increased cash flow or if you are in the growth phase, you could tap into the increase in equity with a cash out refinance. Hopefully with the upgrades you can also increase monthly rent from 2500$ to 3000$ which increases your cash flow by 6000$ annually. Now depending on your tax situation ( AGI, Real estate Professional Status and material participation in the property concerned) or if you choose to do a cost segregation study on the property in the year of acquisition you may be eligible for tax breaks that further offset your out of pocket cost of the rehab by up to 20 – 30%.
Budget: Once you’ve made the decision to rehab your rental, the first order of business is to determine what your budget is going to be. It’s very important to be realistic here so you are clear on what you want to upgrade from the very beginning. It’s very disruptive to the timeline and expensive to have to modify plans later if you decide to bump your budget up and add things. For rentals, IMHO the most bang for your buck is in renovating kitchens and bathrooms and converting at the very least common areas from carpet to hard surfaces so you don’t have to periodically replace the carpet if pets and kids have trashed it. Most of the time, cosmetic changes give you the most bang for your buck and moving plumbing lines or electrical fittings or tearing down walls can be expensive without a proportionate yield. I have also found that in a mid size renovation (if you are spending over 10-15k), especially if structural changes are being contemplated, it makes sense to include an architect in the initial planning. They usually get paid by the hour and their opinion and expertise could save you a bunch of money overall or at the very least ensure that your money is spent in the most high yield items in pursuit of durable and contemporary materials. You do not want to tear down walls only to later realize that there was a more cost effective solution to provide you with a better result in terms of flow in the space. Or to replace your countertops to later realize that you should have upgraded to larger appliances as they are the norm in your market. Oftentimes having someone experienced look over the renovation plans (especially if you are essentially functioning as your own general contractor) saves you money and frustration in the long run by guiding your choice of materials, appliances and helping you figure out the most cost effective way of getting to your desired outcome.
Sourcing your Materials: As the adage goes ” Kitchens sell homes”. Upgrading appliances makes your rental more attractive for sure, but other things to consider are upgrading tile countertops to single slab countertops and maybe a complimentary backsplash etc. A natural stone countertop like granite is durable, renter proof and these days very cost effective especially if you go the per-fabricated route. That being said, more and more rentals including commercial spaces are getting quartz countertops. Lately, LVP (Luxury Vinyl Plank) flooring has been taking over the lower to mid home markets – it is durable, water proof (which also means kid and pet proof) and you could run it into the kitchen and baths at or below 4$/sqft including installation. That being said, tile flooring is another hard surface flooring that while being slightly more expensive installed, increases the value of your home a tad bit more. And last but not least, a coat of paint does wonders in transforming a room. Sourcing materials for your rehab can be challenging the first time around, but once you have done the research, visited the big box stores like Lowe’s, Home Depot, Costco and all your local showrooms for flooring, appliances, hardware, lighting etc you are now armed with this invaluable knowledge base for your next project. The learning curve is frustrating but steep and if you stick with it, it is very, very rewarding. If you plan on renovating multiple rentals, it helps to use the same materials for flooring, same paint colors etc in all your rentals, this ends up being time and cost effective and if a plank of flooring need to be replaced or paint touched up, you have it handy. Find the formula that works for you, then rinse and repeat. I do want to point out here that it helps to start with a design concept and stick to it so your end result is cohesive in terms of style, scale and color – all of which enhance the vibe and overall elegance of your space.
Building your Team: If you are using a general contractor (GC) for your project, then this part is much simpler. You get a few good references and go from there. It is much harder if you are your own GC for cost considerations or if you are trying to materially participate in the renovation to qualify for Real Estate Professional Status. You will need to have a reliable flooring installer, electrician, plumber, painter, cabinet and countertop guys and handyman for drywall repairs etc. Building this team can seem like a colossal task, but doing the legwork, getting the quotes and finally assembling your team is very gratifying. In my experience, the more experienced licensed professionals were well worth the up charge in the quality of work and insight they brought to the job and I would recommend keeping that in mind while comparing quotes. The most frustrating part of working with your team is unforeseen delays in the time line as this pushes out the other members in the team due to the sequential nature of most rehabs. Changing your mindset to expect these delays shifts your energy and helps a ton.
If you have been acquiring turn key rentals, I hope I have inspired you to try rehabbing your next rental. Don’t let inertia hold you back. It will seem hard many times along the way, but if you stick with the plan and push through, you end up learning so much that you will carry with you into the rest of your real estate journey. Look before you leap, but I assure you, if you take the leap of faith, you will be rewarded ….