Two school of thought.. which are you?

15 Replies

Was just pondering this idea, which I think may be a real thing for myself and probably has been for you guys as well.

When you buy a rentable place for B&H, that has the basic necessities but is overall older. Do you:

a) Rent it out right away for a lower rent, or

b) Upgrade it, then rent it as a standout unit for a higher rent

I will also provide a hypothetical example. You purchase a place for $120-160k. You can immediately rent it for $1500, or you can put an additional $20,000-25,000 in upgrades and can rent it for $1900-2000. Lets say you have a day job and are not doing REI full time.

Are you sure you could get $1900-$2000? In the areas I operate fully renovated places for "oldness" and not additions only get an extra $100-$200. Plus your pushing market value. I probably would rent it out for the higher value possible and than increase the rent when their are natural breaks or when my tenant was going out of town and I could get in their for 2 weeks.

If I were to buy it without a tenant, I'd do something in the middle. Make it look nice and fresh, replace worn-out items and make sure everything is in working condition. Wouldn't go for a standout unit. May shoot for $1600-1700 in rent and 5-10K in upgrades depending on condition (the less the better). 

I'm curious about other responses, so monitoring.

@Elizabeth

Yes I am sure. Because a realtor investor I know did exactly that ;) Put $20k in upgrades into a unit in that same condo complex (same sq ftage even) and rents it for $2000. Have a copy of the nice crgslist ad and everything.

i bought with multi unit with tenant. rent was 425. When tenant left, I put 4000 in to bring up to code and refresh. I put back on market @ 500. No questions asked, didn't even bat an eye. It was a studio. 500 is high. Got renter before I advertised.

When I bought this multi one unit was in bad shape. I put 20k into it then rented it for 550k... Previous landlord only got 475. Also rented right away.

Meanwhile i put in new roof and maintained the building.

I only have 1 unit left, bought with tenant, rent is 700. Once she leaves I'll put 20k in it bc I can get 1000 for it after.

Are you assuming you buy it "ready to rent"? It would depend on the cash flow potential, as many upgrades do not translate into that much higher rent. Also, holding costs accrue when a place sits empty, so I would want to see it rented quickly.

I would also take into consideration the location, the current condition of the unit, the market and many other factors. We aim for safe, clean and functional first. Comfortable and good looking second. Our market is "affordable housing" so we would not do upgrades for the purpose of commanding higher rents.

If we are going by the Original example I would rent it out for $1500 as opposed to putting another 20-25k to get to 1900-2k

I would view the renovations as another "purchase " and see if the ROI made sense.

In your example, you'd get an extra 4,800 to 6,000 a year for spending 20 to 25k. That's a 24% gross yield! I would definitely do that.

Plus, generating that extra 4,800 to 6,000 a year on an existing property means you won't have to find another tenant and incur all the activities and expenses associated with that. There are economies of scale with both time and money.

@Paul C.   Thanks.. I think I would lean towards that in this particular example. Have never tackled a remodel, so should be interesting.

@James Wise  Why would you choose that approach?

Yeah, I'm with @Paul C.  on this one.  Your hypothetical is going to be tight any way.

I'm assuming 20% down, ~4000 in closing costs and for that you'll pay renovation expense out of pocket.

Here is your property as I see it somewhere were taxes are low and insurance is medium:

Mortgage Rate 5.00%
Length of Mortgage in years 30
Monthly Mortgage payment $515.35
Taxes $100.00
Sewer and Water $-
Trash $-
Heat/Utilities $-
HOA $-
Cap Ex and Ops $150.00
Insurance $100.00
Mgmt Fee $150.00
Vacancy $120.00
Total Expenses $1,135.35
Total Revenue $1,500.00
Cashflow/month $364.65
Cash on Cash Return 15.63%

Same place after renovations:

Mortgage Rate 5.00%
Length of Mortgage in years 30
Monthly Mortgage payment $515.35
Taxes $100.00
Sewer and Water $-
Trash $-
Heat/Utilities $-
HOA $-
Cap Ex and Ops $150.00
Insurance $100.00
Mgmt Fee $190.00
Vacancy $152.00
Total Expenses$1,207.35
Total Revenue $1,900.00
Cashflow/month $692.65
Cash on Cash Return 15.68%

You get the same return on both properties but MUCH nicer cash flow after renovations.  Assuming it takes 6 months to complete the renovations, you'll be behind $15,810 (9k rent, 6.8k expenses) so you'll pull slightly ahead in month 49 of renting.  

15810/(692-364) = ~48.2 months

So the value of this project depends on your length of investment.  If you plan on holding the place for 48 months or less, @James Wise  is correct, you'll make more (assuming you make $0 on exit).  If you plan on holding it 49 months or longer, you'll put more cash in your pocket by doing the renovations.

You should also be wary of your exit strategy.  Will the fixed up place give you a significantly high resale value for the property in X months?

I think that you can better use the $25k by pputting it into another deal as opposed to spending it on renovations that will take 5 years or so to get your capital back.

I would run the numbers, lots of variables.  How long to renovate (i.e. lost rent).  I have a house in the Canton area in Baltimore.  It rents for $1,500.  I could put another $15,000 into it and get maybe closer to $1,900, but to me, it rents at a good rate (it's already paid off) and it rents fast, so hard for me to justify putting $15k into it.  I think gradual upgrades (between tenants) is the way to go.  It limits downtime, and you increase rental rate and market value over time (sometimes slow and steady does win the race!!)

Keep in mind guys, since I hear a few of you mentioning vacancy, that the vacancy on Oahu, Hawaii is 0%. Myself and Bob B. on here can attest to. Typically, cash flow % is dismal here compared to the mainland, but I usually have a line of 15-20 people to rent my studio the day I put a craigslist ad out.

Originally posted by @Andrey Y. :

I will also provide a hypothetical example. You purchase a place for $120-160k. You can immediately rent it for $1500, or you can put an additional $20,000-25,000 in upgrades and can rent it for $1900-2000. Lets say you have a day job and are not doing REI full time.

 In your example the extra $20,000 will get you $400 extra a month or $4,400 a year allowing for vacancy. That is a 22% return on your money.  That is the appropriate way to think about it. However only you can decide if it is worth it given your finances, and goals. 

Without adequate market studies of your specific neighborhood, you may over-improve the dwelling. I think that before sinking cash into a unit to upgrade it (vs. using the cash to acquire additional units), your rental comps have to be solid, taking into account the actual vacancy losses incurred by higher-cost units.


As @Rob Gribben  pointed out, you might get more money, and even a better tenant, but will you have more turnover and is the cash worth the downtime? Canton is a funny market, and I don't think you have too many folks renting for more than 2-3 years because it's a young crowd there for their first job before they get married/sick of the bar scene/enough money to buy a place. I'd personally be weary of improving beyond the B range of rentals in that neighborhood. 

In Oahu, your place has to radically overpriced or a total dump not to rent within a weekend. When we were looking for places, our application was usually in a stack of 4-5 fully qualified, great tenants, and 10 more "ok" tenants.

Another reason I hesitate to improve more, the higher the rent, the more likely you are (at least in Canton), to have 3-4 roommates sharing the house.  I like to target singles or young couples who can afford $1,500, but at $1,900, it's too much for many.  If I add another bath and finish the basement into a BR, sure I get more rent, but more people living in the house = more potential for headaches (potentially anyway).

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