Renovations as Cashflow Killer

10 Replies

Hi. I recently bought a triplex for $235,000. It is fully rented and each unit rents for $725. This is my first rental property and I'm not sure how rentals should look. I mean I fixed it up to where all safety issues that the home inspector found were fixed. In addition, all non-functioning items were fixed. Having said that, the cabinets are quite old and worn out and each units probably needs a renovation. I won't be surprised if it took around $6,000 to renovate each unit.

But here's my question. At $725 a month, how will I ever make this up if I spent $6,000 renovating each unit? This will kill my cash flow for several years!

Did I do it all wrong? I got conventional mortgage on this triplex. Should I have tried to fix it up first and somehow tried to get the cost of the renovation included in the mortgage? How do people do it here?

I typically hear people in the podcast buy beat-up properties and then fix it up. How do you do this when doing conventional mortgages? 

Can I get a HELOC on my primary residence for this purpose? Can I fix it up and then re-finance?

@Christopher R.   Why are you renovating the units? Is it that bad where it's needed? Are your tenants paying on time and not complaining? I would leave it alone and not waste your money unless you're looking to flip it anytime soon.

A smart renovation will increase rents and decrease vacancy and maintenance costs.  Over improving is only good if you are learning skills on a test property that can be used on better properties.  

It looks like the mistake was in the original analysis. Total cost is $235k + $18k = $253k. As a guideline, you'd like to have 1% of that in rent per month: $2530 / 3 = $843 per unit. If you're not able to raise rents to that level then you're probably not earning a very good rate of return on your investment (NOI and CoC return rates.

You could get a HELOC and/or fix-up and refi. However, that's potentially throwing more money after bad. As @Michael Barbari  said or implied, postpone the rehab or raise rents after rehab.

It sounds to me like you're mixing multiple "ideas/strategies" with no rhyme, reason or understanding of each. I don't mean that negatively....I mean it as we all don't know what we don't know, until we know it. 

You update rental units based upon a necessity to do so that will command more rent, or due to obsolescence. This is often different for different rental price points and areas. Don't confuse "old" cabinets with "need" to be replaced. That may be true in your area, or it may not because that is the usual conditions of rentals in you area. You have to know your market and market rents to find out.

The buy/rehab/ hold strategy is one that I have used. Yes I do the updates before tenanting it, and I'm paying cash. Loans come afterward so I can get the costs of renovation back. If you're going conventional that's what it will take, or doing two loans the purchase and a cashout afterward. Personally that probably isn't worth the expense. When I do it I'm buying something that isn't currently finance-able and then getting the value add of the rehab...doesn't sound like you'll get much of that here.

Real beat up properties that you usually get the deals on, often can't be financed conventional. So that strategy is not usually going to work as well for a buyer that needs to purchase using financing.

You make money when you buy. If these units need the work now, they needed it when you bought. You should have accounted for the cost either by reducing your offer or getting the repairs credited. 

@Michael Barbari  - The tenants are not really complaining and they seem to be paying on time. I guess being new at this, I have this "idea" in my head of what's appropriate for a rental property. But I guess if someone's willing to pay $725 as is...

@Raj Gandhi - It does seem to me that I can raise the rent to low 800s if I fix the place up but I guess the question I need I need to answer for myself is should I? I mean, even if I raise the rents, it will probably just break even with the HELOC costs. I guess this is where @Bob Bowling comments comes in. Does the renovation make sense? Is the vacancy rate too much? Are the tenants leaving too often because the place doesn't look nice enough?

Good food for thought for me. 

Originally posted by @Matt Devincenzo :

You update rental units based upon a necessity to do so that will command more rent, or due to obsolescence. This is often different for different rental price points and areas. Don't confuse "old" cabinets with "need" to be replaced. That may be true in your area, or it may not because that is the usual conditions of rentals in you area. You have to know your market and market rents to find out.

Matt, I guess I guess I have to get out there and do some detective work and see how my competition looks like. Are the units close to me all updated or are they "older"?

It all goes back to the numbers. That is one of the tricky things to understand when you are first starting out. Your question is spot-on though, and one most people don't ask, but it's the best one to help you learn how to evaluate rental properties. The majority of properties out there either don't make sense from a cash flow perspective or barely make sense. The primary thing is- always include estimates for repairs and renos in your upfront calculations when analyzing properties. If it will need actual reno or rehab, figure out those numbers ahead of time. If it's just on-going maintenance you'll need, use an estimate % and include that in your cash flow calculations.

I'm not sure if this triplex is in Cary (I don't even know anything about Cary), but just realize that cash flow isn't obtainable in all markets. If a property costs too much, you won't get cash flow out of it.

Not sure if this helps, or is the right time to show it to you, but here is the formula I use every time I evaluate a rental property for potential purchase (you'll have to include costs for reno in there--put it into the total purchase price).

http://www.biggerpockets.com/renewsblog/2013/01/19...

That's all in terms of cash flow as a response. The other way you might be able to make that money back is the appreciation on the property due to the reno, if that happens.

Medium hipsterinvestment logo black300dpiAli Boone, Hipster Investments | [email protected] | 310‑957‑2101 | https://goo.gl/x52ZKJ | CA Agent # 01911993

Renovating can also help attract higher quality, low maintenance, boring tenants.  This brings a different kind of value that doesn't easily translate into $$$.

First, you did not make a mistake.  You are learning by experience.  You can read and learn all you want in advance of making a purchase but there will still be things to learn. 

There are obviously multiple strategies that can be used here.  If an apartment needs updating you can sometimes negotiate that in with the loan.  I have done deals where the bank holds on to the renovation money and feed it out as the improvements are done.

Perhaps they don't need to be renovated and could just use a facelift on each turn.  Cabinets don't usually need to be replaced if they are wood.  Replacing the cab doors could be a less expensive option.

I like to renovate.  I usually pick older properties in great locations and update them.  These types of deals may see $100 rent bumps if done right.