Adding Square Footage Can make a Skinny Deal a Big Deal

A fellow Real Estate Investor & JV Partner of mine, recently bought a single story single family home Bank REO at an online auction for $130,000. At the current comps of $140 a foot, the 3 bedroom, 2 bathroom, home, rehabbed, would sell tops for around $182,000. With $30,000 in rehab and holding costs etc., the margins look pretty skinny. That's the bad news.

The good news is when looking at market comp sales, the average house sold in the area is actually around 1,900 square feet. The opportunity stood out like a beacon, at 1,300 square feet our project is 600 square feet smaller. Okay, so the answer is easy, add square footage to the rehab build out.

To make it easier, a large patio runs three quarters of the length of the house, and by essentially pushing out the back of the house, we were adding an additional 700 square feet. At $140 a square foot, this translates to a $98,000 increase in value. The rehab budget increases exponentially and we have to apply for permits and inspections which add to the timeline. However, having the ability to move the sales price from $180,000 to $280,000 is a huge deal!

The black bold lines of the rendering below show the changes and addition being made.

To enhance the interior we are removing the wall which separate the kitchen from the living area, moving the ceilings up to angled cathedral ceiling following the new roof tresses, creating and airy open living environment. We are also adding a fourth bedroom.

Realistically, our expectation is to sell the project for around $260,000 with a rehab budget of around $67,000.  So essentially we take a skinny deal and turn it into something that has real meat on the bone.

WARNING!

The only way this works in this particular instance is because our project house is smaller than the average comp sale.

In the event that your project's living area is larger than the average comp sale in the neighborhood, in a typical appraisal your project would not get full credit for the additional square footage, but only 50%. So, for example of our project house was already 1,900 square and we added an additional 700 square feet instead of an upside of $140 a foot, we would only see an increase of $70 a foot. So you need to be aware of your increased construction costs and how it compares with the net upside gain.

There are some projects that you come across, which lend themselves to additions and expanded square footage as part of the rehab for exponentially more profit. You need to the following in mind when doing this.

1. What's the average living area square footage for comp sales in the area?
2. Is my project square footage lower or higher or the average?
3. The secret of making a home larger is that the expansion or addition should look like it was always part of the home. In other words, NOT an obvious addition. We have all seen them, obvious additions can make a home hideous and unsaleable.
4. Make sure that you comply with all of the local building regulations, codes and compliance, and do what is required. If you do not, you may have trouble selling the property, and prospective buyers may have challenges getting the project to qualify for financing.
5. Always run the numbers multiple times, and get as many opinions from professional third parties as you can.
6. Always be sure to employ a good architect, engineer (if needed), and an experienced GC for Permitting and Inspections. Your GC should recommend individuals you should work with, but still tread with caution. Check references and talk to other guys in the industry and by the way just because someone is expensive it does not mean that they are the best.

Oh, did I say triple check your numbers? Okay triple check your numbers.