How much can I afford to spend on a rental upgrade?

Question

The Section 8 tenant who has lived in my rental for two years has given notice, and in addition to the usual maintenance to make the single-family rowhouse ready for next tenant I'd like to make a couple of important upgrades.

How could I analyze the amount I can afford to spend on an upgrade based on projected gross rent receipts? Or net rent receipts?

I know how to determine the appropriate purchase price when acquiring a property, but I've already had the property for three years. I own it free and clear, having paid about $33K (including settlement fees) for it three years ago. I invested about $6K in it after acquiring it.

Here are the upgrades I'd like to do:

Install new HVAC (with or without AC? I don't know)

Pull up carpet and install vinyl plank resilient flooring

Replace crummy, warping laminate kitchen counter

Uncover a skylight that was drywalled over in a bedroom

The townhouse is in Baltimore City. I had been getting $1207 in rent from Section 8 for it as a two-bedroom plus den home. If I uncover the skylight and the den becomes a bedroom again, and I upgrade to central air, I believe I could get more--but it's unpredictable, so would like to analyze from the previous rental amount. I plan to hold this rental for the long term.

Is there a method to help me figure this out? Would appreciate guidance.

Nancy Roth

Dumitru Anton · Answer

@Christine Swaidan, allow me to answer that: 2 years is the timeframe a medium (not stellar) renter could make your newly renovated unit into a dump, even with every 6months inspections.

but also, if you get a good, clean tenant (notice the change from renter to tenant= they think of your property as home), you don't have your money in the property for more then 2 years, which allows you to respond to changes in the market.

@Nancy Roth, I would also focus on durability and ease of maintenance. Also remember Kitchens and Bathrooms is the way to a woman's heart.

....I would recommend the "Lazy Landlord" series here on BP.

Nancy Roth · Answer

@Jd Martin Hi, I take Section 8 all day, but also accept the need to do heavy, consistent screening of all applicants. Section 8 recipients are just like any regular market tenants--some are bad, some are good. Due diligence is necessary.

Appreciate your comment about how fast you expect to recoup the expense. I assume you mean in net operating income. When I first acquired the house I did not know enough to rehab proactively as you do. I just fixed what didn't work. Now I know better. When you buy a substandard house, what do you aim to spend on a proactive rehab?

A trustworthy contractor thought the lower kitchen cabinets were sturdy, so it could be granite going in if I can get the right price.

BTW I'm not putting in a skylight to get more rent, I'm opening the drywall ceiling to reveal an existing skylight so I can call the room a bedroom. Without a window it cannot be advertised as a bedroom in Baltimore.

Thanks for taking the time to write.

JD Martin · Answer

Thoughts in no particular order:

1. When I buy a property there is a baseline that we bring the property to on rehab before putting it on the market. Those are part of the costs of doing business. This is also our niche, i.e. buying substandard houses at low prices, full rehabs and healthy rents with minimal capex for a long time. If I am doing something to a house that was outside of that initial rehab, and beyond basic maintenance, I expect to recoup in 2 years or less.

2. If the lower cabinets are quality and are staying I would consider low-end granite. Otherwise it's laminate.

3. None of your proposed improvements are going to increase your rent amounts IMO. Tenants expect floors, counters, heat (and air in some places). Your improvements may make your unit easier to rent but no tenant will pay for them (outside of the HVAC, you may get a little bump there depending on what other units are like). No one is going to pay for a skylight. Adding a bedroom is a whole other matter and will increase your rent.

4. I don't take Section 8.

Thomas S. · Answer

Most of the big expenses you are suggesting are a waste of money for welfare tenants. They cost too much and will not generate any greater returns.

When renovating you ideally want to see a full return within two years or less with the higher rents.

HVAC, especially air, don't bother. Tenant pays for electric so not a benefit to you. Install if you want right before you sell. It will not add to higher rents.

Defiantly get rid of carpets, this will benefit you by reducing future expenses but again will not increase rent.

I would replace the counter top for personal reasons but again it will not increase rent.

I would defiantly put in a closet and there by add a third bedroom, I do not understand the purpose of the sky light and would not touch it.

Adding a third bed room is the only improvement that will warrant higher rents and is relatively inexpensive. That is your only worth while improvement.

If you intend to continue to rent to welfariens you have a captive tenant pool. It's government money, there is no reason to spend money to improve the property simply maintain it to the agencies standards. Any other money spent on them is wasted and only cuts into your profits.

Nancy Roth · Answer

@Michael Gansberg

Thanks, this is so helpful.

May I ask further, is there a minimum investment return below which you will not go? Based on MLS figures for rentals in or near the neighborhood of this rental, I don't think I will get more than $100 / month in additional rent. Of course I'll advertise for more, or if it's a voucher holder, request more, and whatever I get over $100 is gravy.

I don't think I can do this work for under $10K. It's a little more than cosmetic, unfortunately. There is no HVAC at all in the house; the previous owner, who was rehabbing it when the housing disaster hit, installed electric wall heaters to save on cost, I think. They work fine but hog electricity and obviously are not ideal as a sole source of heat. Also resale value of  the house is going to be much lower if there is no HVAC at all!

So it would be a whole HVAC system going in, ducts and all. HVAC plant and ducts is $7-8K alone. I could save $3K if I don't add CAC but it seems pennywise & pound foolish to leave out CAC while I'm doing this!

So using your formula, simple return is $1200/year / $10K invested is 12%. Return on this rental has been much higher, in the area of 30%, pretty spectacular. Still I have to keep up the property if I want it to continue getting a good return, and I do want to be able to sell it one of these days.

If you were in my place would you do this scale of repair?

Appreciate your advice,

Nancy

Jeff Bridges · Answer

If you consider installing central air, I would put a security cage around the condenser in baltimore. But it doesnt look like you have a good rate of return on installing a condenser for $4-5k plus cost for security cage. Can you command any more for section 8 in your area? If not, your rate of return on these upgrades is very limited. These upgrades would just help your unit rent faster or maybe for longer. Do you think your area can target market rate tenants besides section 8? that will dictate if you can get higher end tenants willing to pay more for these items and whether local market has competition for central air units. Check current listings or rental comps and see if any offer central air and what they list their rent for? Also check the kitchen condition. this is how I determine the level of upgrades for my area and I try to make mine very slightly better quality than my comps only to rent it faster, but not necessarily because I expect I can charge much higher than the competition.

Michael Gansberg · Answer

Hi Nancy,

Here's how I like to do it. I compare the quantity of funds put into a rehab(or in this case, cosmetic fixes) with the likely yield on that money. So for example, let's toss around some simple numbers. Perhaps you can do all of the above work for $5k, and let's assume the new rental amount increases by anywhere from $50/month to $150/month(I don't know the Baltimore market, so I don't know how realistic this is.)

On the low end, your simple return is $600/yr/$5k invested which is 12%.

On this high end, your simple return is $1800/yr/$5k = 36%.

Let's say you calculate your return on investment in a new property to be 15%. In that case, the above modifications would likely give you a higher return on invested capital(except in the "floor" case, where you only net another $50/month, but even that is pretty close.)  If your return on invested capital is higher by doing the modifications, it's probably a better idea to do those. Even if it's close- it's still probably a better idea! Here's why.

If your rent is higher by $600/year, using a gross rent multiplier of 5X, you've increased your property's value by $3k. If your rent is higher by $1800/yr, your value is higher by $8,000. So that's the icing on the cake. The less tangible aspect of the cosmetic changes, but in my view, most important, is how it will likely affect the change in tenancy. A better apartment attracts a better tenant, and also tends to stay occupied a higher percentage of the year.  So if you go from a vacancy rate of 8%(perhaps the local average, but I don't know, I just pulled it from a hat,) to 3%, that will really improve your bottom line. And if a resident is happy with their apartment? That really changes things- instead of hearing complaints, you'll hear nothing.

I also recommend swapping water and energy hungry fixtures(notably, the toilet and showerheads and any incandescent or swirly bulbs) to water and energy efficient counterparts. Specifically, go with LED bulbs(not the lousy ones from Ace hardware, but good ones with nice light quality,) and a .8 gallon per flush toilet(from Home Depot- Niagara Stealth) and a 1.75 gpm showerhead. Your bills and your tenant's bills will go down, and that will also increase the value of the building.

MG

Christine Swaidan · Answer

@Nancy Roth This is a topic that is near and dear to my heart as I have done seven rehabs this year on one bedroom units and always question whether I REALLY want to invest the money. Definitely makes renting them easier which is a good thing. I'm one of the rare individuals on this forum that is not interested in enlarging my footprint and can see myself selling in a few years so my goal is to increase property value.

Definitely would not open up the skylight in the bedroom. They leak and some want to sleep in complete darkness.

Laminate counter tops  are cheap. Do it.

If it were me I would put in the HVAC system. Easier to rent now and easier to sell later.

Third bedroom is very smart.

Thomas S. I've wondered if there was some formula that would determine how much I should spend. Is the two year full return just your own personal comfort level?

Thomas S. · Answer

Do the sky light to get the third bedroom. Don't waste the money on even cheap Granit. It is over the top for your class of tenant and believe it or not they will damage it. Stay with laminate. It is inexpensive and easy to replace.

As far as the HVAC is concerned if section 8 handlers do not require it, likely hood it will not increase  government rents,  then it is of no value for you to add it. Wait till you are ready to sell.

How much can I afford to spend on a rental upgrade?

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