Quantity vs. Quality: When does a rental reno cost too much?

Question

When does a rental home renovation cost too much?

I purchased my first home while college and it needed a ton of work. I used this home as my “crash course in home renovations”. I did all the work myself by watching YouTube videos and asking a few friends for insight (aside from moving a gas line and a some electrical) but I feel I went overboard with the reno budget. I don’t regret the money I spent since I have learned so much about renovations.

I have no idea what I spent on the rehab. I did small bits over 3 years when I could spare some money and find supplies on sale. I was a broke college kid! I have no plans to sell the home in the near future. The interest rate is extremely low, I have great equity, and with the university expanding I don’t fear demand will dry up.

Home: 3 bed, 1 bath, 2 car carport, 1780 sqft. The home is in Lubbock and roughly 1 mile from Texas Tech University and a half mile from two major hospitals.

I listed the home the week before Thanksgiving. I priced the home about $100/month over what other 3/1’s rent for in the area. I figured the home would sit on the market for a few weeks since this is an odd time of year, it has one bathroom, and it’s more expensive than 90% of the homes in the area. However, I was pleasantly surprised. After being inundated with calls from prospective tenants, I had to remove the listing after 4 days. I showed the home to 7 people and 5 them wanted to put a deposit down the same day. So, I rented the home in less than 5 days and receive $415 in cash flow/month.

I’m on my next project and I’m in the process of rehabbing the property now. We plan to purchase another home in 10 months. (rinse and repeat)

I want to gut the majority of the property or at least make the home more appealing than 90% of the homes in the neighborhood. Spending extra on mechanicals and materials to increase the lifespan and designing the house so can be easily maintained (adding service panels to shower control valves or vanities, etc.) Also, while improving the layout and design of the home with above average materials.

Here’s my theory: (all assuming the cash flow is positive and enough to cover expenses)

If I can over engineer the property and spend a little more now, I will reduce the risk of costly repairs caused by mechanical failures like water leaks, HVAC issues, or durability of fixtures. The home will stand out among the other rentals, lowering vacancy and reducing turn-around times. I want my rentals to look better than 90% of the rentals in the area, and I want to appeal to top notch tenants that are willing to pay more to have the best. Also forcing appreciation will increase the equity in the home and allow me to pull money out of the property sooner. [Reduced repair costs, lower vacancy, higher quality tenants, higher rent, and more equity.]

The downside of this theory:

1. I can’t know for sure the home will appeal to high end tenants.

2. Forced appreciation is not a guarantee or at least I can’t guarantee I will break even

3. I’m reducing my cash-on-cash return by putting more money into the property

4. I could be spending the extra money on purchasing more homes. (quantity over quality kinda thing)

5. The opportunity cost of spending more time remodeling a rentals slows my growth

Ignoring my degree in finance and my rational brain. I enjoy remodeling homes. I take pride in building things with my hands and designing a home that people love. I enjoy the creative aspect of taking a bathroom down to studs and starting over. This contradicts the finance/rational part of my brain that wants to spend as little as possible and move on to acquire more properties.

I’m not as concerned about the property generating large cash flow to “free me from my 9-5”. I have no plans to become a full-time investor or quit my job since I enjoy my profession. I am more concerned with growing the value of my portfolio, reducing risk, and increasing my investment opportunities.

• If I can get above market rent, force appreciation, reduce vacancy, and reduce the risk of large capex, but slow my growth acquiring properties and reduce cash-on-cash return; is it a good investment decision? What risks or downsides to this approach am I overlooking?
• We like to pretend that we are emotionless financial robots, but lets be real.. What value do you put on pride of ownership or the quality of your properties?

**I intentionally left out the numbers and I do realize asking, “is this a good investment?” is a difficult question without reviewing the details. This is more of a high-level/macro view and I’m trying to gain insight to how others view the quality vs quantity conundrum.

Thanks for any input you have!

Bart H. · Answer

I think the answer is it depends.  Clearly, if you put Viking appliances into an entry level student house, its pretty doubtful you can get your money back.

We fall into the camp of over rehabbing our rentals.

1)  We generally try to buy and hold.  Yes our returns are a little lower on paper, but I think we get better tenants.  I think they maintain our properties better and I think we have fewer issues with rent collection etc.

2) If a downturn comes, I want our properties to be the first to rent, not the last.  and if it got really bad, its nice to know with a rehabbed property, you have some equity and could sell on a short notice

3)_ We try and think long term in that if we continue to do a little rehab on our properties real time, in 10-15 years we will have a paid off portfolio that throws off cash in our retirement.  Right now we arent looking for cash from our real estate, everything we get we either reinvest or we buy new.

4) If we truly are at the beginning of a downturn, I dont think its the worst thing to keep your properties near the top of market in terms of condition and to take time digesting each purchase Vs leveraging to buy as many doors as possible.  One imo keeps you in the game, the other runs you the risk of getting yourself into trouble.

IMO the best and most experienced folks in this game have the knack of being able to remodel houses on a shoestring budget to make them look great.  Each time we do a rehab, my wife and I try to digest what we can do to lower cost and time of rehab. IMO we have gotten a lot better.

For instance we use the exact same paint color on every wall in every property.  If we have to go in and do touch up painting for a turn, poof, we have a can of paint that matches and there is less waste.  And we are learning to find places that carry overstock items, or run specials for things like fixtures, appliances and vanities.

John Warren · Answer

@Cameron Lambo there are two ways to look at this question. The first way is to look at the overall mechanical structure and quality of the building. If you are putting in high quality electrical, plumbing roofing or hvac that will last for decades, then in some cases doing it the 100% way makes a lot of sense. This is especially true if your goal is to simply hold the piece of real estate for a long time. I still think it is possible to go over board. For instance, some folk might put a 98% efficiency furnace in when they could get away with a simpler furnace. It might not make a difference to your bottom line as tenants pay for heat, but it could end up being a worse move if it costs more to maintain!

The other way to look at things is how the improvements enhance or detract from your net operating income. I invest in the apartment space, and I want to know how much additional rent I will be able to get for the money I am injecting into a project. I am currently in the middle of renovating a 19 unit apartment building in Berwyn, IL, and we are gut renovating the entire property. Each unit will see a rental bump of at least $250 per month. This rental bump is worth around $40,000 in building value based on the going cap rate!

Obviously, single family homes are not commercial property, but if you can find a way to mathematically quantify your question, you will be happier in the long run.

JD Martin · Answer

My experience:

1. Renters pay for: location, square footage, layout, amenities in that order.

2. Renters will pay for: central heat & air, dishwasher, main floor/in-unit laundry, carpet-less home (laminate, tile, wood floors), off-street parking, fenced-in yard, dry storage (shed, clean basement), some type of clean outdoor space (patio, deck, porch).

3. Renters will not pay for: upgraded heating systems, fancy countertops, energy-efficient windows, high end appliances, fancy kitchen cabinets, fancy bathrooms, huge walk-in closets, high-end window treatments, upgraded door knobs, security systems, fine landscaping.

I rent generally to "B" tenants in "B" neighborhoods. Renters in my category are looking for safe homes close to work & school and away from noise, a big house for their money, a layout that makes sense, and basic & durable amenities so they don't have to walk on eggshells and can get their deposit back when they move.

Chris Grenzig · Answer

@Cameron Lambo if you're concerned about over improving, see what the returns look like if you were to rent it out at the same rent as your other property. If it still does okay, than probably not a bad idea because you'll probably only do better than that. Just another way to look at it without specifics.

John Warren · Answer

@Cameron Lambo my pleasure, and I hope it helps! Not over renovating is one of the hardest lessons to learned.

Cameron Lambo · Answer

@Bart H. Thanks for your response!

Good point on the high-end appliances! I agree that top of the line appliance (and most other furnishings) makes no sense. We are looking at putting a better quality LVP flooring for longevity vs the builder grade at Home Depot. It may be a $1-1.50/sqft more but Ideally it will last longer.

I like your point about improving each time you do a rehab and figuring out ways to lower the cost, but not the quality. Also, #2 is very reassuring!

It sounds like you have put a lot of thought into your investment strategy and you don’t deviate from the plan. This is exactly the framework I was looking for. On a high-level being able to thoughtfully acquire properties while reducing the likelihood a downturn will destroy the value of your portfolio.

I appreciate your well thought out responses!

Cameron Lambo · Answer

@John Warren

Thanks for the detailed response! I like how you pointed out the over efficient furnace. This makes me take a step back and think if a particular upgrade is really affecting the quality/longevity of the property or not.

Your comment about your apartment renovation makes a lot of sense. Since you can estimate the rental increase, the renovation is justified as it will improve the overall value of the property.

In our situation, the numbers work either way. We can improve the property to a level we feel stands out from the crowd or put very little work in the property and move on. I would much rather have 10 great quality properties than 15-20 headache properties.

Great comment and I appreciate your time!

Thomas S. · Answer

Your post comes off as this being more of a hobby than a business.

Points 1, 2, 3, 4, and 5 of the down side of your theory is why smart investors never do what you are planning. It does not make good business scenes to over improve a rental.

You are far too emotionally involved injecting your own personal desires into your properties. Your  degree in financing has not served you well. It is probably a very good thing you do not intend to quit your day job as you will likely go bankrupt as a investor. "Emotionless financial robots" make for the most successful investors.

I would strongly advise you keep your renovating only as a hobby because as a business it will be a disaster. UNLESS you flip the properties.

Quantity vs. Quality: When does a rental reno cost too much?

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