Rehabbing or flipping is almost 100% art. There are very few hard and fast rules. The goal, like in any business, is to maximize profit. Many times I have quoted the old saying that you make your money when you buy a property, and I stand by that statement. Once you’ve made a smart buy the money is immediately yours to keep… or loose. Over-improving a home is one of the best and most efficient ways to give away your money.
The Symptoms of Over-Improving
- Falling in love with the property.
- Remodeling like it was your dream home.
- Confused self Image/ falling in love with the process
- Are you acting more like a builder, contractor, remodeler
- Are you trying to make a model home
- Are you doing improvements just to show how well you do an improvement
- How many times have you said I will get the money back
- Justifying an improvement with a non-monetary return
The Warning Signs
Falling in love with a property is easy to do and hard to identify. You should be in love with a project to some degree. Love is a natural product of you passion for the business. The trick is to know when you have fallen. The best way to stay on your feet is to know your market inside and out and continually compare your decisions against the realities of the market. There are also a few other indicators. We all want to do a good job on our project but you may have slipped if you’re just spending money on things that no buyer will notice or pay for. Small things like door hardware are good examples. Are you spending $30 on a closet door knob when a $5 one would work just as well? Just ask yourself, is this something that would affect what a home buyer would be willing to pay for the home? You’re not being cheap. You’re not cutting corners. If the home buyer is willing to pay more for your home because you have Medeco locks on the house then by all means install those locks. If not then you’re not serving the wants and need of your clients you are serving your own.
Remodeling a home like it was your dream home sometimes has the same roots as falling in love with a property and if this is the case see the previous paragraph. But it is also common in new rehabbers who only know what they like. Their strategy is to make every home the home that they would buy.
Immerse yourself in the market. Go to every open house you can within the relevant market. Talk to the neighbors to try to identify the wants and the needs of the type of person who will buy in this neighborhood. Try to get in their skin so you can design the home for that person. Compare every decision you make against the realities of the market. It is amazing how eager most neighbors are to talk.
A confused self image is pretty common in rehabbers who have a couple jobs under their belt or contractors who get into rehabbing as a way to try to create their own work. New rehabbers can easily start to get a swagger about the remodeling process and begin to think they are contractors. Contractors who do an occasional rehab or move into flipping homes might not fully adjust to their new rolls. Just remember that there are no hard rules. What worked on the last job may not work so well on your current project. What you happen to be good at or comfortable with may not work on a given project.
Here are some danger signs:
Are you trying to make a show place of your construction skills? Men are very proud of manly work, like carpentry. Are you showing off your fancy finish carpentry with crown moldings and ornate built-up trim in an entry level rambler? Contractor, are you trying to make a model home for your construction business? If this is the case then make sure you write off those unmarketable additions to your advertising expense and not be disappointed when you can’t find a buyer to pay for them. In fact when you finally get a buyer not only will they not pay for all those extras, they won’t even say thank you for all the free stuff you gave them. Even if you are primarily a contractor you better change your hat when you walk into your rehab project because you are in a completely new business now.
Many home remodeling contractors base their business model on trying to push every high dollar improvement they can on to a home owner or client. A rehabber does not yet know his client when he starts demolition. There is no customer or contracts guaranteeing you a certain payment. You can’t put a lien on the house to collect payment for your time and materials at the end of the project. Well, you could but it wouldn’t do you much good. No, you either guess it right up front or you work for free, or worse, you pay cold hard cash out of your pocket for the privilege of working.
Keep track of how many times you say “I will get this money back when we sell.” So many rehabbers when faced with a decision to improve or not improve just shrug their shoulders and say improve we’ll get the money back when we sell. Remember that there is a cap on what that property will sell for no matter how much you improve the home. If you find you’re making this statement too often you might go back and add up all the costs that you’ve accepted based on this rational. That combined price just might open your eyes to see that there is no way you’ll get that entire lump sum back. From there, go back and be more selective with your improvements. Having a good plan from the beginning also helps you stay realistic.
A big danger sign is when you start justifying an improvement by anything other than a dollar return at the sale.
Now, keep in mind that every project requires some of these improvements. Curb appeal is a big non-monetary justification. Curb appeal is a huge marketing must. However, it must be kept in proper perspective and under control. There are very few landscaping additions that a buyer will actually pay for, and even fewer that an appraiser will give you a 100% dollar credit for. In most cases bad landscaping will take away from your profit but great landscaping features will not necessarily increase your sales price. Any landscaping improvements beyond just a good clean up should be carefully analyzed against the area comparables.
The Remedy: Know Your Market
*NOTICE*: Your market is usually a very small area.
It will likely be no more than a one mile radius and most times it will be much smaller. Forget those reports on the news about real estate. Forget the statistics for even your town. We are talking microscopic microeconomics here. Your home might be in a subdivision that contains 200 homes. If there happens to be 6 sales in the neighborhood in the last 6 months then those 200 homes are your market. Don’t try to compare your home to those across town or even those in the neighboring subdivision. Those homes are largely irrelevant in your little world. Verify this with an appraiser if possible, but in most cases the appraiser will not allow comps from outside your subdivision if there are enough recent sales within it.
The bright side is that it makes it easier to get educated and stay current on your market. You should continually pull comparables throughout the remodel phase of your project. Know when new homes have gone on the market, how they compare to yours and their list price. Talk to the Realtors who are listing homes on the market and even the Realtors for any recently sold homes. You can also learn a lot about a neighborhood from long time residents. They can give insight into what makes the neighborhood attractive. Just keep in mind that neighbors will have a biased opinion. Take this information only as another piece of a puzzle; never take a resident’s statements as actionable intelligence.
Your target buyer is also part of your market, so you’ll want to know generally who you’re fixing this property for. You certainly want to modernize your home when you remodel it, but you just want to make sure you do it without overspending. Don’t put granite countertops in an entry level home.
Go through builder model homes when possible.
Large builders are very current on what upgrades that home buyers in different price points are willing to pay for. If you have an entry level home that you’re rehabbing then visit several entry level new home subdivisions and tour their model homes. You want to make your home new, fresh and modern but that does not always have to be expensive.
I got a little lazy on one of the flips I did this year. I let an inexperienced partner make too many decisions. I put too much stock in the advice from the Realtor who was listing the house next door, who was probably trying to get my house as a listing, and I lost sight of what grade of home I was remodeling. In the end I made about $30,000 less than what I should have. No matter how experienced you are, always be weary of the over-improvement.
Admitting you have a problem is the first step.
Photo Credit: Qfamily,Rehabbers: Know the Warning Signs of Over-Improvement by Justin Pierce