Am I Spending Too Much to Rehab a Buy and Hold Property?

Question

OK, so we bought our first property in May. A 1930s or so craftsman house. It has character and hardwood floors throughout. We paid $77K, 25% down. We ended up with about $27K in rehab. The place looks great. New sheet rock, foundation, plumbing, etc. It turned out so nice, we'd live there! It cash flows about $350/month (after PI, Insurance, taxes). But I see most PB posters say they spend around $10K with their rehabs, so I'm concerned we're doing too much.

We are about to close on our second house (with garage apartment). It's again a house from about 1940. I estimate about $25,000 in rehab costs. We are paying $93K and 25% down. We anticipate about $450/month cash flow. When we get to the apartment, that will take another $15K but i think we can get about $350/month.

So the question is, how do I account for the cost of rehab in the PB formulas? OR do I assume that I'll recoup those expenses when we decide to eventually sell? Example, I think the first house would easily sell for about $130K or more today.

John Chapman · Answer

I will answer your question about your concern that you are spending too much on your rehab because most people brag about $10k rehabs. Here's the truth. If they are doing a true rehab (like what you are doing) then there is no way they are spending only $10K. I think I've had only one or two $10K rehabs in my career and they were homes in great shape. If you're working on a 1500 square ft home, a $10K rehab is only $6.67/ft. That's a light cosmetic rehab. Nothing more. Once you start addressing mechanical and structural issues (which is what I do when I purchase a new rental), the costs easily escalate to $20-$30k and more. To me, it seems like you are fixing what needs to be fixed. Keep doing that and it will serve you well in the long run.I think what many people in my area doing are buying and doing a $10K rehab, but leaving a lot of deferred maintenance. That bill will come due eventually.

Mark Douglas · Answer

@Brien OConnor said. Painting over drywall is easier than replacing it, just as laying new floor covering is easier than correcting the subfloor damage underneath. Deferred problems don't just disappear, and someone will end up paying for it. Sounds like you're doing it the right way :)

Jeff B. · Answer

Ignore the bravado you hear, work with good locations and basics and success WILL follow.Those Craftman's are real gems and can be a gold mine *IF* you can control the expenses.Use your last efforts as a cost estimator for the next one - - after all, that was reality and no bravado. At the end of the day (aka, your final resale), if your profits are satisfactory to Y O U then ignore everyone else and dam* the torpedo's, full speed ahead!

David Dachtera · Answer

@Brien OConnor,$10K is more like a fix-and-flip: "lipstick on a pig".My house here was built(finished) in 2004. Hardly a rehab, but a full update would be well over $40K to do it right.

Valerie Hiscoe · Answer

There is always a 'range' of rental prices and the more you can keep your property at the top of that range, the more likely you are to have tenants who don't want to risk losing their place by missing their rent or other undesirable behaviour. Make sure that your rental ad includes highly marketable photos and charge just a little bit more than you think. The worst that can happen is you have to drop the rent a bit.

John Chapman · Answer

@Brien OConnor, no, you can't use conventional funding. Most people use private money or hard money. (I use private money from a buddy). I wouldn't waste my time with a bank for a short term loan like that unless they have some sort of product that converts from short term to long term financing. (Would be a portfolio product of some sort.) I like the private money because it's fast and flexible. I've got enough of a track record that my lender will even amend the note if I want to increase the balance. The trick with a conventional refinance is that you want to be just refinancing the note, not pulling cash out. You'll get a better rate and higher LTV (75%) if it's a straight term note refi.

John Chapman · Answer

@Brien OConnor, the only other observation I would make is that it seems like you have a lot of money into each of these deals. That is, you're putting 25% down and then funding the repairs out of pocket. Obviously, you're free to do it this way, but most investors I know are buying with some sort of short term financing, rehabbing, and the refinancing based on a fixed up ARV. (I believe BP calls it the BRRR strategy, but it's been around a long time.) This way you finance at least some of the repair costs and don't have so much cash tied up in each property.

JD Martin · Answer

@Brien OConnor. That's a lot of bravado. It does happen occasionally but not usually.On three rehabs so far this year, I have rehab costs of $27k, $16k, $15k, and I do some work myself because I enjoy doing it. None of the three needed full drywall or any foundation work. One needed a roof, so there was that. Figure it out - the cheapest, crappiest kitchen cabinets you can buy off the shelf at Lowes for a 10x10 kitchen is going to run you $1500 without installation, counters, sink, anything. Trust your numbers and ignore what other people say. It's no different than your neighbor bragging how he got the dealer to come down to $5k under invoice on some car, when the reality is that he probably gave his trade in away for a dollar.

Suzanne Griffiths · Answer

@Brien OConnor the litmus test I would use is looking at the finish level of other rentals in the immediate area. Are you putting granite or quartz countertops where everyone else is putting laminate and getting the same rents? You also need to decide what you as an investor are comfortable with and why you are using the materials you are. Do you want your place to be "Renter" proof, so you are putting in tile instead of sheet vinyl etc. If you are putting finishes in just because you like them and there isn't a purpose or a return on the investment then I'd look at your SOW again and maybe make some changes that do fit in that category.

Brandt Smith · Answer

@Brien OConnor you may get a bit more rent but it most likely is going to go at the market level. They are looking more for clean and updated than anything else.