Rehab Post - The Good, the Bad, the Photo's and the Numbers!

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Anatomy of a Stockton Rehab - Lessons Learned

Rehabbing a a topic that I have experience with. Too much experience really. I thought I'd put some photos together to lure readers and then work some Yoda like rehab-wisdom into the mix.:) Like all my posts this one is not for the faint of heart, as it has once again turned out to be a whopper of a tome... Well, at least it has pictures. I rushed it a bit at the end so I am sure it has plenty of typo's too:) 

Figure 1: This is how I used to do 'eh. All granite, new cabinets, design faucets... Everything new. H*LL YEAH RIGHT? Actually, H*LL NO.....:) I can tell you from experience that this is quite possibly the most expensive way to make yourself feel good:)

Do as I Say, not as I do...

As I mentioned, I have gotten quite some rehabs done. The one I want to use as red thread for this post is a recent one. The back story is worth mentioning, both for entertainment value, and for the lessons that can be learned from it.

Last summer I acquired 3 properties. Two duplexes and a Triplex. They all closed just before the end of the month. There is your first lesson. Don't do that! If you never bought an occupied rental before this is how it works: If you take a property over the new owner is prorated the rent for the current month at closing. So if you buy a house on the 10 the of a month you get the other 20 or so days prorated. Closing early in the month like on the second or the third does not only help lower the closing costs, but also gives you a full month to establish contact with your new tenants and do a smooth transition.  Closing at the very end of the month however forces you to scramble to knock on doors, get rental agreements signed etc. This is not smooth at all and comes across very unprofessional to the tenants.

Because of this we did not screen the existing tenants like we might have done otherwise. Second lesson alert... If you take over a building screen the existing tenants. You have no idea what kind of detritus the previous owner just shoved in there to get the property sold. My advise: Screen all existing tenants as if they were candidates, and give them notice if things look too bad. This would have saved me a lot of headache, but again, we did not do this...

Altogether we took over 7 leases those few days (it was a holiday weekend too). After some going back and forth 6 of the transitions went about as smooth as they could have been (under the circumstances). However there was one tenant with whom everything was difficult... Everything. From getting a list of who lived in the property, to providing ID, to not being able to pay online like everyone else, not willing/able to fill out a maintenance wish-list etc. etc. Everything was notably difficult compared to any of the other tenants... This should have cued us in right there... Stockton has very fair tenant laws and in retrospect we should have not tried to facilitate the tenant, but given 60 days notice right then.  This is another lesson: If someone is "being difficult" about everything in the beginning you are in for a rough ride. Stockton is a landlord's market and this too should have made us call it right there...

Figure 2: My tenant was a "lady" but you get the idea...

Loosing a Tenant, Gaining a Dog...

Fast forward about 4 months during which everything was "difficult". Late payments, stories, self inflicted service calls, general obstinacy and general drama. Late payments with stories turned into partial payment with stories and then into just stories. Again we should have called it right there, but we allowed ourselves to be strung along from October to December when we finally filed for eviction for non-payment of rent. By this time we had not received rent for 3 months already. Once the eviction got started the tenant kept insisting that she did not have to pay or move because she "had hardship" (elderly family member passed away etc.) and would take the cause to court for a dramatic movie worthy legal victory.

Her court experience was not quite what she had imagined it would be and we got a ruling in our favor. TIP: Document all your tenant interactions and always be professional and to the point. Our meticulously documented service calls and resolution proved very useful in the argument with wild emotion.

When the Sheriff finally did the eviction we had not see any rent for 6 months in total. The apartment was in a bad shape. The laminate flooring was torn up beyond repair, most interior doors were kicked in, and everything was extremely dirty. Fortunately the cabinets were ok. There was also about a dump trailer load of junk left in the property. Oh yeah, and a full sized dog. After initially biting the contractor the dog calmed down a bit and continued to live in the side yard and chew on the fence and the building for the next two weeks until we could get a shelter to come pick it up.

Figure 3: This is a stock photo, but you'll get the idea. That dog weighed more than some of my ex-girlfriends:)

 TIP: Don't allow pets in small low income apartments. If you can get tenants without pets why take a chance on the ones with pets. There is no upside and plenty of potential downside... 

Figure 4: I tent not to take a lot of BEFORE pictures. Because its too depressing. This one should give you a pretty good idea what depressing looks like. BTW we did a property inspection on this unit when we bought it and besides the fact that there was someone sleeping in the laundry hookup closet it was in pretty OK shape then...

The Turn

I try to make my apartments the high end of the low end. Meaning that I try to offer a nicer place to live than is typically offered.  I used to go way overboard with this, but have gotten better. It took me a while to figure out the simple truth that I am not trying to rent an apartment to ME.... The people that are willing to live in duplexes and triplexes in the neighborhoods that I have buildings in care amazingly little for the apartment being extra nice. If they care, this does not translate in wanting to pay more rent. Tenants at the lower end really think different from buyers. Simple to understand, but it took me a while to figure this out. That being said: this is the package that I apply to my units:

~ I always change out all windows and slider with new Vinyl windows and doors. I don't know If I recommend doing this, but I like the fresh, squared away look that it gives the exterior particularly combined with the paint job I put on all buildings I acquire. I typically change out the windows and doors one building at a time, but if a tenant moves out that is too good of an opportunity to miss.

Figure 5: Two tone paint scene, new base boards, vinyl windows, vinyl plank flooring. I should buy stock in a vinyl company...

~ Fix everything that is not 100%. For example change out shower and bath valves that  are not 100%, change out angle stops below vanities, sink etc. 

~ Refinish cabinets if they are at all salvageable I used to put in new cabinets regardless, but found that that has a horrible ROI plus it increases your exposure to damages.

~ Refinish the sink if I leave the counter-top in place. I used to go all granite, but try not to anymore not just because of the cost but also because of all the hassle and coordination it requires.

Figure 6: My handy man has gotten pretty handy at refinishing sinks and bathtubs.. The counter top was still ok. The cabinets are re-stained in a dark walnut if I remember correctly. Note new switches and plugs.

 ~ Most interior doors were trashed so we got these switched out with nice looking 6 panel doors.

~ I always have an empty unit re-switched/re-plugged with the modern looking square outlets/switches. This looks good, takes care of any worn out plugs, and allows us to put GFCI outlets where they should be according to current code.

~ Paint: I have a 2 tone paint scene + white ceiling paint we apply to all units. This is the best ROI of all rehab:).  This make touch up work down the road easier, takes to decision out of it. I also implemented a bold accent color that we apply to one wall, or a fireplace. TIP: Board any fireplaces up for safety. This also saves on your insurance. Tenants don't use the fireplace anyway, and if they do and there is a fire, do you want to explain to the insurance company why you did not have the chimney professionally inspected by a licensed inspector 2X per year? 

Figure 7: Tataaaa! The accent color. I think it called "Spicy Cayenne" hmmm... People give me sh*t about it all the time but it's bold and therefore achieves its purpose of standing out:).

~ Light fixtures: are all changed out to a standard fixture with an LED bulb. I only put LED bulbs in any of my properties. They last forever, are energy efficient, don't generate a lot of heat. Most tenants are not very handy, so particularly the fact that LED's last basically forever is really great. Because in the end their problems will become my problems:).

~ Faucets. If they are original we change them while we are at it. This will save work down the road when calcium and rust makes the old ones clog up.

~ On this project some of the vanities were trashed so we put in new ones.

Figure 8: New vanity, cleaned tile cleaned bathtub, new toilet. I always change out old ratty looking toilets because - why not. Notice how nice the new windows look. We cut a ratty part of the bottom of the mirror added a tile strip and hung it back up. I used to replace mirrors with ratty looking edges but have not been able to find an affordable reliable mirror source.

~ Flooring: I used to go with tile or carpet. Tile is expensive, and hard to remove in the future. Carpet will wear amazingly quick. That's why my new favorite flooring is LVT (Or Vinyl planking) It is basically vinyl, but its laid in strips. Unless you feel it it looks exactly like real wood (and its really resistant to abuse). Its also easy to clean and since its plastic its water resistant. It's a bit more expensive than carpet I am hoping it will be worth it. I hope to find a cheaper source for the material in the future.

~ Stove was wrecked so we decided to go with a basic stove. For my nicer units I go with a flat top which looks nicer and is easier to keep clean, but I resisted the temptation on this one.

Figure 9: New Stove, refinished cabinets, LVT on floor, 6 panel doors, neutral light fixtures. If I were to do it again I would change them out of recessed LED lighting, which is actualy realy cheap since it just involves 4 holes an 4 pack of inserts.

After the rehab, which of course took way too long:(, the apartment looks really good. It took only one open house to find qualified new tenants that were ready to move in. Maybe I should have priced it a bit higher? I tend to under-price myself in order to "rent it quickly"... Maybe there is a lesson in that too...


The Economics

Lets talk some cold hard numbers... First rule of rental rehab. Never ever rehab a unit that is already rented. Keep everything in good repair, but don't ever upgrade occupied units. I've hear the argument that "you can get more rent" but its not worth it. If you disagree do this: Raise the rent with the amount that you thought you'd get after rehab. If the tenant stays, don't rehab because you got your money. If they do leave you get your chance to rehab anyway:)

Figure 10: That's right. The economics of a project like this are total b*llshit:)

Between the new windows, doors flooring, etc etc. etc. this whole project was about $12 to $14k that includes labor materials, dump hauling etc. This might seem like a lot but I find it to be pretty typical. if I would have upgraded the cabinets etc. I could have easily spend $20K. 

If people are interested and I feel like I might break it all down, but I can assure you that if you see all the break down you'll see that I did not overpay on anything. It's just that a lot of different smaller things add up.:(

As far as rent. This is a 2 bed 2 bath unit that was renting for a ridiculously low $750. I raised that to $850 right away with the old tenant. I am now renting it for $1050. While that is a robust $200 more than I was getting before the rehab, I hope this shows that rehabs do not have a great ROI.

If the tenant would have been a normal person I would have been able to raise the rent to $950 without rehab. So Basically a $14K rehab is giving me a $100 upside. It also cost me 2 months of occupancy. 

So $14,000 + $1700 (vacancy) + Lots of headaches = $100 per month. Yay! I'll break even in 13 years!:((( That is if I don't have another tenant wreck the place in between.... And if the cabinets and bathrooms last that much longer... 

What makes it worse; if I ever were to sell the property, the investor I sell it to is not really going to care, at least not enough to actually pay me more money!

This is one of the draw back with residential property. Any property will sell for what your neighbor just sold his building for. (Comparable valuation). If this was a commercial apartment building the math would have been different. Those building are valuated not on comps but based on how much Net Operation Income (NOI) they generate. Lets say the cap rate in the market is 7% (7 CAP). This means that $100 per month which is $1200 per year. That makes the math: $1200 / 0.07 = $17,000. This means that if you raise the rent by $100 your buildings value goes up by $17,143! As an added bonus apartment building owners can execute way cheaper because they can buy materials in bulk and use their own maintenance people for most of the labor.

That brings my to my conclusion: While it can feel very rewarding to beautify a property, rehabbing residential income properties (duplexes/triplexes) is an evil that should be prevented if at all possible. The juice is definitely not worth the squeeze. So if you desire "feel good", there are definitely cheaper ways to achieve that...:)

 Now Give the Man his Props...:)

I spend quite a lot of time on this. More than I'd like to admit. If you liked it, or at least got something out of it do me a favor and click VOTE, so I know I am not just doing this to contract carpal tunnel...:) If you have any questions, try the comments!

Figure 11: Now give it up!

Place looks great.  Love your analysis.  You may have overimproved, but you know you did and it seems like, in general, you're mostly ok with it.

If you're happy, who cares?

Nice work Chris, now i argue the same thing with myself regularly. I just end up doing the minimal it takes to rent it because as you've mentioned, the ROI is horrible and the people will not really take care of what you put your hard work into.

I focus rather on flooring that doesn't go bad, tile, good laminate.

Decent quality everything.. middle of the road brand name stuff that's good rental grade.

Then i renovate before selling.. that's where you'll get more bang for your buck, i just do not renovate for tenants unless something has gone wrong.  Because at the end of the day, they rented it for that price.

Also, one other thing, if your getting 100 less per month on an un-renovated unit, raise the rents to half that, pocket the money and use the rents to cover your next fix up.  Working well for me and i have quads and tri's in stockton as well.

Good luck!

Originally posted by @Linda Weygant :

Place looks great.  Love your analysis.  You may have overimproved, but you know you did and it seems like, in general, you're mostly ok with it.

If you're happy, who cares?

Happy, HAPPY?! :) Anyway, thanks for the kind words, however, my point here is not so much about over or under improving, but about the economics of residential income properties. Nobody likes to talk about the real cost of turning a property. Sure, people like to make some assumptions regarding "CapX budget"... However I think that most people that are "analyzing" a residential income property kind of "analyze" the CapX budget away...

Could I have spend less rehabbing this? Certainly. However, even if I would have been able to half the amount that is still a very, very significant amount especially if I would only have this one duplex. Fortunately  for me I have a larger portfolio that helps me even things out. But, exactly because I have a larger portfolio I know that there are always unexpected expenses. Every year its something else but stuff happens all the time. Example: a backpack HVAC  unit costs about $4200 (installed). On average I have had to replace more than one of those per year...:( I must say though that because I am really aggressive when I acquire properties they tend to get a lot lower "maintenance" after the first 18 months or so when I got them squared away and got the bad inherited tenants out.

So, don't get me wrong, I am not complaining here. I am able to sustain myself off my rental portfolio, and that is more than most can say. However I do think it is important for especially newer people to realize that CapX is a real thing for residential income properties and a significant cash flow killer... Especially if you are considering buying properties at today's market prices...

Anyway I'll get off the pulpit now:)

@Chris V. Thanks for spending the time and effort on this post.  Very well done.

Originally posted by @Mike Wood :

@Chris V. Thanks for spending the time and effort on this post.  Very well done.

Thanks!! I realize that I place a good amount of emphasis on "the bad & the ugly" in most of my full sized posts, but I think its important that especially newbies get a balanced view, and not just the rainbow-unicorn success stories that everyone likes to pitch. Realizing the true cost is important, particularly now that the market is becoming less forgiving of mistakes...:(

That being said, maybe one of these days I should post one of my success stories:) I should be able to come up with one or two somewhere, given that I do live of my real estate now...:)

Chris,
Thanks for taking the time to write this post and pull everything together; it was very informative and educational. We have two properties in Stockton and we struggle with how much we should invest to upgrade the units versus just doing our best to maintain the units in the best condition we can for ROI purposes. You really help lay out the numbers and pros/cons. Keep up the good work!
Metra

Originally posted by @Metra Ulloa :

Chris,
Thanks for taking the time to write this post and pull everything together; it was very informative and educational. We have two properties in Stockton and we struggle with how much we should invest to upgrade the units versus just doing our best to maintain the units in the best condition we can for ROI purposes. You really help lay out the numbers and pros/cons. Keep up the good work!
Metra

 Hi Metra - Glad to hear you got something useful from the post! That reminds me, I spend Sunday afternoon creating my budgets for the rest of 2017 and 2018 and  should probably use those budgets as the basis for another post where I dive a little deeper in the numbers. 

The good thing about having a number of units for a while is that after a while statistics kick in and you get a pretty good picture of how much everything costs. 

The main take away I had from that afternoon playing with numbers was that while my cash-on-cash return is great on stabilized properties, my Return on Equity in those property is really horrible. If I could get my equity out without paying taxes or realtors I could private lend it and get the same returns (I get 12% annualized for a first mortgage) and but not have any work/worries! 

It took me a long time to realize how important a metric ROE is. All the other metrics are nice to make you feel good about your investment savvy, but ROE basically tells you how efficient you are with the assets you really have at your disposal TODAY:).

I found this post very helpful and informative. Thank you!  

Great post....

If you flip you do not use best quality materials.  Trex composite deck is substituted with Douglas Fir, use laminated or engineered wood not solid. 

Your advice regarding renovating of rental units is on the money. The overwhelming number of owners, especially new ones, will never see the return on their investment. Many justify the time effort and money by convincing themselves they are making the effort to provide the best quality living environment for their tenants. Regrettably few tenants realise or appreciate the expense.

Renovation expanse wise the only expenses, beyond necessary repairs, are those which the financial cost can be recouped through the portion of the higher rent in under two years time. If that is not realistically possible the owner might as well be flushing their money down the drain. They have made a poor business decision to spend  beyond a two year pay back. Additionally if you have other repair expenses ongoing you must curtail your reno plans.

The maximum a investor should be spending for every $100/  month in additional rent is $2400. 

It is a fools decision to do unnecessary reno upgrades when raising a below market tenants rent to market level. Those investors are the least financially responsible of all. 

The reason many investors fail is due to renovating units to satisfy themselves. Believing they are being socially conscience is a fools path to failure.

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