Financial Modeling of Renovation/Rehab Costs

[Michael K.]

You acquire a property that as a renovation/rehab play, not necessarily just for the units themselves, but also improvements to be made to building systems and exterior . . . Let's say you already know the approximate $ figures of the costs of the renovations you plan to make to the property. I usually just add this amount to the cash invested equity portion. But I am curious to see how others might be incorporating renovation/rehab costs in their financial model, especially if these changes are done over time, a period of a few years perhaps. Also, where you are adding these costs to - to the equity portion? taking additional debt? seller concession? How do you typically account for these renovations costs in your financial model?

[J Scott]

Are you talking about a SFH or an apartment? My answer would be different between a SFH rehab and an apartment value play where you're building equity by increasing cash-flow.

In general though, there are two options:

1. Assume all rehab costs are laid out upfront as part of your purchase costs. If you plan to hold the property for a while, this will skew your annual cash-on-cash return numbers as well as your IRR, but it's easier than trying to forecast when your expenses may come if you don't know. Also, this is a conservative approach, which is never bad.

2. You can try to forecast your future outlays, and use your income and outlays to build a model that predicts your IRR at various points in time, depending on when you ultimately decide to sell. This will give you a more realistic assessment of your return, but is obviously dependent on your being able to forecast your rehab expenditures.