This is a guest post from Curbly House partner and real estate investor, Jon Peterson.
If you’re following along with our Curbly House project, you know we’ve just embarked on a pretty ambitious home rehab project. We spent months searching for the right property, and now it’s time for the fun stuff to begin (demo, construction, staging).
Have you ever considered taking on a similar project? It can be a very rewarding experience; you get to take a home that’s in poor shape (often vacant), and add value through thoughtful improvements. That’s good for the neighborhood and good for the happy new owners, and hopefully you can make some profit along the way.
But where do you start? How do you find the right home? What are hidden obstacles along the way? This article will set you on the right path to a profitable home rehab.
Is the location right?
The old saying rings true, especially when rehabbing homes. The single thing you can’t change is a home’s location, so be sure that you know the neighborhood inside and out. Spend some time driving through area at various times of day … a block can look much different at 10pm than it does at 10am!
Remember, you want to find a property in an areas where lots of people want to live. That will give you the greatest possible market for your renovated home. Make sure you consider things like school districts, proximity to restaurants, bike lanes and walkability. Avoid busy streets, and homes in close proximity to industrial areas. Above all, remember who your potential buyer is. By having a good idea of who you want to buy the house, you can ask the right questions about the location.
Good Repairs or Bad Repairs?
Aren’t all repairs a good thing? Well, yes and no. Your job when rehabbing a home is not to fix every single thing that’s wrong with it. That just wouldn’t make financial sense. You need to figure out which repairs add the most value, and make the house appealing to the new owner. It’s ok if there are few things left for the buyer to handle … that’s just part of owning a home. But you need to make sure you address the issues that are causing the house to sit on the market.
A good repair something that is cosmetically unappealing, yet relatively easily and cheaply remedied. When hunting for a rehab property, you can’t be turned off by something ugly, smelly, or dirty. Old ratty carpet filled with pet stains? Great! That’s easy to fix. Terrible overgrown grass-up-to-your-knees landscaping in the front yard? Excellent! New landscaping won’t cost that much. ‘Dreaded’ black mold on some walls or ceilings? Fantastic. Water remediation and new sheetrock are straightforward repairs.
“Good repairs” are relatively cheap to fix and have a very high impact once they’re done.
“Bad repairs” are ones that are hard to predict, costly to fix, and don’t always add much value. Homes that need major structural work are not for beginners. Fire damage, major foundation issues; these problems can spiral out of control and snowball into different areas of the home. It’s also smart to avoid homes with funky or cramped layouts. A home may be on a great block at a great price, but if the only bathroom is right off the kitchen, or if the bedrooms are tiny with no room to expand, look elsewhere.
What's my turnaround time?
Rehabbing homes comes with holding costs. There are taxes, insurance, utilities, the cost of financing, and, perhaps most importantly, the opportunity cost of not rehabbing your next house! While it may be fun to think about rehabbing that castle-looking-4,square-foot mansion, the truth is there won’t be many buyers looking for that type of house, once you’re done with it.
You want your rehabbed home to sell quickly, which means you need to have as high-demand a product as you can. Depending on the area, this usually means shooting for a 3 or 4-bedroom home with 1-2 bathrooms, likely in the 1500-1800 sq ft range. Again, this will depend a lot on the part of the country you live in. And again, knowing who your buyer is will help you understand the type of homes you should be exploring.
Do I have the right help?
This is probably the biggest mistake I see made among beginning rehabbers … using a family member or friend as a Realtor, or even just sticking with the same person who helped you buy a home in the past. Do not treat this transaction the same way as you would a normal home purchase! Find a Realtors who works with investors; they have connections to help find off-market homes. They have unique insights into areas that are prime for rehab projects. Most importantly, they can help identify the types of repairs that bring the highest return on investment, and warn you off improvements that won’t be worth the money.
What's my target sale price?
It’s counter-intuitive, but you need to work backwards. Depending on your budget -- and thus, the price range of the homes you will be rehabbing -- you may be selling your finished home to vastly different audiences. If your budget is $150k, your finished product will likely be a smaller home that is perfect for first time homebuyers. If your budget is $400k, you may end up with a 5BR home in a nice neighborhood. If you are looking at $150k homes, you likely won’t be using granite/quartz counters and customs cabinets … but these are standard in most houses above $400k. If you keep your final sale price in mind at all times, it’ll help sort out the rest of your budget.
Have I seen enough houses?
Do your homework on the front end. You want to walk through as many houses as you can. Even if you are an absolute beginner, you will be shocked at how quickly you will start to see patterns and trends just by walking through homes while talking with your (hopefully) investor-savvy Realtor.
Don’t just walk through homes that may be candidates for rehab projects. Make sure you walk through finished homes that somebody else has already rehabbed. You want to see what types of products and repairs are being done, and what those homes are selling for. Figure out what looks great and what seems like a waste of money. Then you can watch to see which rehabbed homes are selling quickly at asking price, and which ones are lingering.
How much should I pay?
This is perhaps the most important question. After all, nobody gets into rehabbing houses to lose money. Once again, you need to work backwards and be diligent with your math.
Find out your ARV (After Repair Value … how much you think your house will sell for once it’s fixed up).
Then startg getting bids for the work that needs to be done. Factor in your holding costs and selling costs. Subtract all these costs from your ARV. The resulting number is your break-even point. From there, you have to figure out the lowest amount of profit you are willing to take, given the time you’ll be putting into the project, and the risk assumed. Subtract your lowest acceptable profit number, and you have your maximum offer price.
Does all that math sound like a lot of work? It is, and it can be tedious if you are looking at 10-15 potential homes per week. Investors have something called “the 70% rule” to cheat a little. This is not an exact science, but it will let you know if you are at least in the ballpark of a profitable deal. You take the ARV and subtract the ballpark cost of the rehab. You then take that number and multiply it by 0.70. That is the maximum you should pay for the house. For instance, if a home is going to sell for $200,000 after it is fixed up, but it needs $40,000 rehab, you should offer $112,000.
Once again, this is just to weed out the terrible deals. Once you have some deals that fit this rule, you need to run the rest of the numbers to make sure everything makes sense.
Hopefully this short guide will help you on your journey to finding that next great rehab project! Leave any additional questions/tips you may have in the comments section below!