Questions about "adding value"

[Matthew Lewis]

So I totally understand how to add value to a rundown property by doing the work myself -- it's good old-fashioned sweat equity (more properly termed "trading time for money.")

What I don't understand is how it works to add value (at least profitably) by hiring it out. I mean, every realtor I've ever discussed home improvements with has basically the same list of improvements, and all of them claim a negative ROI. For instance, spend $10k on a kitchen remodel, increase your value by $8.5k (or whatever, but it's always less than the expense).

I figure I must be missing something, because BiggerPockets is full of investors talking about their contractors, etc. I just don't understand how to hire out the improvements and still make a profit on them.

Could someone explain how this works?

[Becca F.]

For #1 many of those are off market properties. You can look them up on your county site: foreclosures, divorce, death, auction, tax liens. It really depends - sometimes with foreclosures, the owners are so upset they're losing their home, they will start destroying it. I've seen faucets ripped out of bath tubs, insect infection, holes in walls, etc. Some people use wholesalers. Some agents have access to off market properties. 

#2 Sometimes it's an elderly person who has a lot of equity and who's taken care of the property but they want to sell without putting in upgrades (quartz countertops, new kitchen and bath). Or adult kids inherited a property and don't want to deal with it and sell As-Is either with an agent, wholesaler or direct buyer. 

#3 There's also Subject To where you assume the seller's mortgage. I haven't done this but I don't think too many sellers would want to do this and if many lenders are agreeable to this set up. 

I've only bought off the MLS using an agent. If you've never bought property before, I would recommend using an agent. if you try to do this on your own without any agent, do lots of research and know your the rights as a buyer, contract terms, etc. You could be easily ripped off.

I can't speak to other states but I know in San Francisco Bay Area, LA and San Diego (expensive coastal cities) that if someone buys at a discount then can do a fix and flip and make a nice profit (before capital gains tax). For example, buy a single family home for $980,000 flip it for $1.4 million (true recent example in San Diego a realtor showed me). I don't know what they spent for the renovation. Trying to rent out a $1.4 million house is unlikely to cash flow positive as a long term rental - a lot of people in CA are doing mid-term or short-term rentals. 

I also invest in Indiana and don't see those large margins - a flipper there might make $10,000 to $40,000. I'm not a flipper, tried it (made 2 offers, decided it's too risky). For $10,000 to $20,000 that's too much risk and I'd make more money in a high yield savings account at 5% interest. Flipping might be difficult with 7% interest rates now, less of a buyer pool. Rental grade renovations tend to cost less than flipper renovations because renters will do more wear and tear so you don't want to spend a lot of money on high end things that you need to fix or replace. A flipper is trying to get the highest sales price possible so they will make the house look really nice so a primary home buyer becomes emotionally invested in the house and makes an offer. 

Your offer price and the renovation costs and ARV determine if it's a deal. If one of those is off, I wouldn't buy it unless you have a very high risk tolerance or lots and lots of money.

If this is your first rental property I would buy local or within 2 hour drive where you can check on the renovation, not out of state. I'm losing money on OOS. You could buy a duplex, live in one side, fix up and rent out the other side (the negative is living next to your tenant but some people are fine with that). You'll get a sense of it's "$5/sq ft for LVP flooring" or each window costs this much, exterior paint job is $6000, permits, etc Add up every little thing including light switches and electric outlets. Maybe talk to some contractors to get a sense of how much things cost or if you can walk some projects local investors or contractors are doing. 

Are you in California?