Should I rehab one of the duplex’s even if it cash flowing now?

Question

Hey BP team,

I have this situation where the property  I have in LA county  has 1 duplex with the ability to add an ADU as well. Both units are rented bring a little cash flow $50 a month. The one home is 1929 it as tenants in it, but it needs a total upgrade/power only 50 amps/nothing is up to code and it 2bd/1ba. I have people in there now paying 2k , but I was thinking of a total remodel of the place where I could get $2,400 - $2,600 per month.

The question I have is would it be worth doing the upgrade to this unit being out of pocket 8 months of rent + $250k for the upgrade? or should I let just go? Should I just take the $250k I would put into this place and find another?

The other thing on the property is I can add an ADU as well, and I was thinking If I add that and then do the property upgrade on the one home.

My question is how do you calculate the value of making these upgrades, and is worth doing this or taking that extra money and going to buy another place?

Any help would be great.

Jeff Copeland · Answer

Would you pay $250k for a property that rents for $500/mo?

A $250k investment to get an extra $500/mo in rent is a .2% cap rate. That's a terrible ROI in terms of cash flow.

It could possibly make more sense from an equity standpoint, if the $250k investment raises the value of the property substantially. But that only helps you if you sell or refinance.

Theresa Harris · Answer

updating so it is up to code and safe is one thing, but if I read your post correctly, you'd be out 8 months rent ($16K) and $250K for the upgrade...and it would rent for an extra $400 a month.... hard pass on that one.

Andrew Strauss · Answer

Hey Tom,

1. The home is up to code and is liveable and have made some simple updates like adding an AC and other fixes to make the current tenants very happy.

2. On the 250K I'm thinking without a total tear-down I might just keep all the walls and vault the ceiling and just update inside with an open floorplan, electrical since it's only 50 amps, and update the bathroom. So It might only be 125k. I do have my contractor that could do this and might be able to work a deal with him.

3. On the cashflow so this is just year one, and we are at breakeven with this place, but I also have a garage that I'm renting out for storage now. I was thinking of making that into a 400 - 500 sqft ADU. This way I can keep the current tenants paying the $2k and then just build this new unit that I think could bring in $1800 -$1900 a month. Once that is complete, I could look to update the other place but could still cover the expenses on this property.

Tom Carroll · Answer

Few thoughts on this.1) If your home is not up to code now and there is an issue, would insurance cover it or would they deny the claim? I would think you would be fine but not often thought about. 2) On the surface spending $250k for a renovation to make $500/mo wouldn't be smart as your payback period is 41 year, 8 months assuming your rent doesn't increase which we know it will3) If doing the $250k investment increases your property value can you refinance? If you do, how much will your cashflow be at that point (answer: less than $500/mo)Overall thought: only do it if it keeps the place habitable and rentable. Otherwise your $250k is probably best deployed elsewhere. Can you build relationships with other contractors that could do that work for less?

Andrew Strauss · Answer

Theresa thanks for your take. Realy helps.

Dan H. · Answer

Rehabs, remodels and virtually all value adds take work/effort.  Your increased cash flow does not justify the cost or effort.  I have never done a $250k value add but my general rule is I expect my value adds to increase the value two times their cost to justify both the effort and cost.  I typically far exceed this minimum goal.  For a $250k cost, I may lower this doubling expectation slightly.

What is the expected value produced by this update?  I likely would pass if it does not increase the value at least $450k.  The minimal cash flow (cost to increased rent makes this a negative cash flow if financed) hurts this value add, so the value add has to be substantial enough to justify the fost, the effort, and t overcome this horrendous cash flow return.

Good luck

Should I rehab one of the duplex’s even if it cash flowing now?

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