rehab not flipping - buy and hold worth the cost of fixing??

30 Replies

Hello and thanks in advance for reading/commenting,

I posted this here because of the 'rehab' question. I would not look to flip this property since I am looking to add to  my b/h portfolio.

Please see end of post for property info.

On any other clear day I would look past this property. I try to find properties that are already 90% for move in. Lately I've been beaten to the door – just when I found one there was already a contract offer but the listing agent didn't update the MLS so my agent didn't know. K

Anyway, I’ve been through two “remodels” of a kitchen and 2-baths, not yet gotten into a “rehab”, which is what this property looks like.

Definitely needs a roof, hvac and water heater, most would say nix on the windows and just leave them in place along with the floor. The kitchen I couldn’t find any quantifiable reason to keep, and believe me when I say I look to keep everything unless absolutely necessary to replace.

I came up with a “very rough” estimate of $25k for material and am stumped for labor. I asked one GC I’ve never worked with before about looking at the property and he wants $125. I have a GC that has done work in the past for me on 2 other properties and yet another GC that did work on one property. I plan on asking one of the GCs that I’ve had do work for me to look at the property.

My question comes in the form of wondering, as a buy and hold investor, when there seems to be substantial work, where should the line be drawn on the rehab costs?

Is this a good buy for a buy and hold although there is substantial work, and I look at roof, kitchen and hvac as substantial enough?

Do buy and hold investors even go this route considering the ROI will be years relative to the rehab costs? It would be a first for me.

If this were a property that didn’t need all this work, it would rent well, though the PP wouldn’t be $60k it would be around 125-134k from what I’ve seen of sales and comps.

I realize that I don’t know anything of labor costs until I get an ‘estimate’ from the GC but the materials I have priced to the extent of roof, hvac, painting, flooring (if it needs or would be pulled up and new put back down), dry wall patching (minor), garage door, interior doors, 2-exterior doors, kitchen cabinets/counter tops, appliances. And because I’ve had these items done in the past on other properties, I’m confident of my materials numbers and what I see in the store.

The cash flow is for a livable property in this area.

Bedrooms: 4
Bathrooms: 2
Year Built: 1962
Square Footage: 1,733

** Purchase **
Purchase Price: $ 60,000 (owner asking 129k already dropped from 134k)
Purchase Costs: $ 1,200 (closing 2% of PP)
Rehab Costs: $ 40,000 (very rough estimate, material est was 25k, labor ???)

** Cash Flow (Monthly) **
Rent: $ 1,300
Vacancy: 8% (-$ 104)

OI: $1196
Expenses: -$ 561 (all in for taxes-$2100, ins-$1000, PM-12%, r$m $780, capX $780, license $204)
Net Operating Income: $ 635

PI: $243 (based on 60k purchase) 

Cash Flow: $392 (this is based on 60K)

looking to do costs out of pocket strong maybe on rolling into a construction loan (called by many names). if rehab costs are financed it would be $149$ cash flow relative to all other monthly expenses


** Returns **
Cap Rate: 12.7%
Rent to Price: 2.2%
Gross Rent Multiplier: 3.8
COC: 8.8%


** Notes **
Looks to have foundation issues back wall of garage. Section of concrete block appears to have been removed and put back.

Back - closed porch (off kitchen) roof leak.

**Needs**

HVAC
Water heater
Roof
Windows (17 unless the old ones remain until they just have to be replaced)
Garage door
Kitchen (can’t find anything salvageable)
Baths (possible clean-up of shower and bath tile, maybe replace sink and counter and toilet)
Interior/exterior doors (needs all)
Paint (interior, exterior looks good)
Flooring (tiled over terrazzo, some terrazzo exposed. Might due well to fix in some areas)
Appliances (need all refrig, stove)

I guess the biggest question is how do you plan to finance this? If you've been approved on a 203k FHA loan then it would be more of a no brainer. You must have multiple GC's give you some bids though because if you underestimate your repair costs you can quickly go from profit to loss. In most cases, we underestimate the work needed and it bites us in the end both time and money.

Get an expert opinion whenever you can. Their experience will intuitively see what we disregard.

Garrett

I don't plan on living in the house, I believe if I'm not mistaken that a 203k FHA requires me to live in the house.

I planned on talking to my lender about a portfolio loan so the offer of $60k and the rehab costs with the exception of 20% down payment would be financed. I should say whether it's a portfolio loan or not, the same lender that I've worked with and used in the past has told me they offer portfolio in addition to the regular Freddie loans. I only have 2 mortgages now so I'm under the radar, so to speak.

I read J Scotts posts on his MD rental that he purchased and it seems akin to what I'm trying to determine. Except in his case he bought the property and was already determining the rehab costs (little to more).

I'm trying to determine:

My question comes in the form of wondering, as a buy and hold investor, when there seems to be substantial work, where should the line be drawn on the rehab costs?

Is this a good buy for a buy and hold although there is substantial work, and I look at roof, kitchen and hvac as substantial enough?

Do buy and hold investors even go this route considering the ROI will be years relative to the rehab costs? It would be a first for me.

Thanks @Garrett F. for answering.

I'd go for it if you are confident in your GC. Worst case fund the rehab out of pocket and cash out refinance later. You might find coming out of the rehab it'd be better to make it a flip, or you might decide to keep it. 1200 rent on 60+40k cost should cash flow nicely especially with all new stuff.
I'd go for it if you are confident in your GC. Worst case fund the rehab out of pocket and cash out refinance later. You might find coming out of the rehab it'd be better to make it a flip, or you might decide to keep it. 1200 rent on 60+40k cost should cash flow nicely especially with all new stuff. Guess my only question is if the owner is asking 120 how do you plan to buy for 60?
Originally posted by @Will Stewart :
I'd go for it if you are confident in your GC. Worst case fund the rehab out of pocket and cash out refinance later. You might find coming out of the rehab it'd be better to make it a flip, or you might decide to keep it. 1200 rent on 60+40k cost should cash flow nicely especially with all new stuff.

Guess my only question is if the owner is asking 120 how do you plan to buy for 60?

1-"rehab out of pocket and cash out refinance later" Please explain this concept?

2-originally it was 134k and at the time I thought it was decent since it's in high-renal area without even seeing the inside. I did some research and found the owner moved in with her daughter or son (guessing) about 2 hours away. Or whom she moved in with - I looked up her mailing address on this property record and found the place she moved to 2 hours away in a very nice community. Her name is not on that property but someone else's.  The records show homestead and the disclosure shows she vacated 4 months ago (time sensitive to july) so it means it was not rented. After being on the market for 49 days it dropped to 129,900. Then I thought, ok I'll go see it.

3-it's nasty. We didn't want to touch anything while inside. The garage has junk in it and smells of urine. Evidence of a dog/cat feed bowl was in the kitchen. Some kind of wall foundation issue in the garage. I won't repeat but in my original post I talked about the condition of the house and what needs to be replaced/fixed. She is not going to fix or do anything to the house, it's an "as is". These items are a must: roof, (disclosure also points to a leak on the back enclosed porch), HVAC, water heater, kitchen. Several door interior/exterior and the garage door need to be replaced.

4-i'm not seeing a whole lot of flipping in this area. I'm watching a couple of homes to see if the people that bought them are going to flip them. Time will tell since they are still working on them. I'm also not a flipper and would rather hold the property.

The owner has lived in this house for many, many years and did nothing to it.

So my $60k came from ARV of the area for this being fixed up. Perhaps that is not the right thing to do as ARV may just be for flips but, I am trying to determine a price and I don't want to even offer 120k knowing that there are sufficient rehab items that need to be addressed. I came up with rough material cost only if I replaced (HVAC, windows, flooring, kitchen, water heater, roof, paint, interior/exterior doors, garage door) and I didn't even put the baths in here.

Also trying to determine as a buy and hold, just what price and rehab is doable from a ROI perspective. I buy 90% already in the condition to be rented with very minor items that need addressing.

I see others that buy and hold, J Scott has a thread on his rental so I read through that and it's a buy and hold, and has been rehabbed.

Baring that the major items are HVAC(5k), water heater(400.00), kitchen(2-3k), garage door(1100), windows (4k), paint interior.... that's 15k+/- right there based on having replaced these items in the past at other homes and that would be materials.

What I'm left with is windows.... replace them or leave them in hopes they stand up but I included them...

It's an 1773 sq Ft house and I was given some numbers from a local GC on estimating material costs for things like paint. So for painting the inside one color walls, trim, ceiling it's another $1,275.

I could go on but as you see I'm being careful to include as much as possible to come up with a cost going in and I know I'm not accounting for everything.

What I've seen about homes like this in my area are they start high in price and the owner finally realizes it's not selling - I wonder why. The condition of some that I've seen is really bad and they want market if not more.

@Daria B

You mentioned 60k being the ARV (after repair value) but it's on sale for 129k?

The idea with cash out refinancing would be buy for 60k (with or without financing), put in 40k cash for repairs. At this point let's say the house is worth 130k. You can then refinance and take a loan for 130k*0.75 = 97.5k. Paying off your first loan and rehab costs leaves you 2500 total out of pocket. Look up the BRRRR strategy from @Brandon Turner

That being said sometimes it's best to avoid total dumps as your first major rehab(ask me how I know) because of things that will pop up. This sounds like it could be one of them. But everything can be fixed. 

Originally posted by @Will Stewart :

@Daria B

You mentioned 60k being the ARV (after repair value) but it's on sale for 129k?

The idea with cash out refinancing would be buy for 60k (with or without financing), put in 40k cash for repairs. At this point let's say the house is worth 130k. You can then refinance and take a loan for 130k*0.75 = 97.5k. Paying off your first loan and rehab costs leaves you 2500 total out of pocket. Look up the BRRRR strategy from @Brandon Turner

That being said sometimes it's best to avoid total dumps as your first major rehab(ask me how I know) because of things that will pop up. This sounds like it could be one of them. But everything can be fixed. 

Hi Will,

No, the $60K is what I would offer because the ARV was a number that I determined (roughly) after the property was fixed up. I know that the ARV is used and worked backwards to get the offer price. Sorry if I confused what I was saying.

The list right now is 129k, started at 134k a few months ago.

I came up with ARV of 130-140 based on sales and comps. I then took 70% of that and deducted what I see so far as "material costs" and some "labor costs", not all labor because I don't know what those items would be. From that I came up with another rough figure of $30-40 (lots of padding) and deducted that to get my $60k.

Ok I see what you mean by "cash out". So in essence, say I wrapped the $40k into the financing with the offer of $60k (100k), and that's of course getting it at $60k (there might be a number as a max that I could live with, with rehab), do all the rehab and then refinance and pay off that 1st note. Likely I would need a strong ARV going in of course, so the 1st is paid off by the refinance, the refinance would have been appraised hopefully at or above the ARV if I and my realtor-comps did this right. At this point I get money back from the refinance (as you say to BRRRR and yes I've read Brandon's strategy on that). Now I take that money and find another property - meanwhile it's "income" (?) - I know that is a question for a CPA - I'm not flipping the property but it seems I did get some money from refinancing that I'm not sure if it's considered income regardless how I use it. @Brandon Hall

Wouldn't I still have to come up with another down payment on the refi?

In short though if I don't have the cash to do the refinancing I'd have to wrap that into the note. The LTV on the ARV in this example puts me under the 1st note (hypothetically if the ARV is that amount). I'd have to have cash in order to do this right or my expenses for rehab need to be way low.

This is why I like to buy property that has little to no need for fixing - this seems all too complicated to do and the need to have more money, ie down payment, cash for rehab, etc.

What happened on your 1st rehab?

My objective is to get a property to hold as an investment.

@Will Stewart

Without pictures it sounds worse than it may be. It's the "hidden" stuff that I have to be weary of like that wall foundation we found in the garage.

In reality, HVAC, water heater, doors (in/out), windows (maybe?!?), flooring (terrazzo covered with tile - not sure on this one), roof (must have done), kitchen (must have done - should be no more than $2000-2500), garage door, paint inside.

I wouldn't knock out walls, or move the HVAC and WH (although they could be moved into the garage to free up space in the house), no plumbing lines, inspection would determine the electrical - owner had a 200AMP upgrade done a few years ago.

All in all, as I go through this list it seems like the typical - in your experience you did a flip albeit with some issues - still want to hear about that - but this list as it were, seems to be a GC and some time to get it livable.

This is why I am investing in @J Scott books. At first I didn't think it would apply to my situation as a buy/hold investment - but now I'm finding properties that need fixing that are in very good locations. I tried for one but the owner didn't want to sell and then found out she sold to another investor. I'm waiting to find out what it actually sold for. The public records have not been updated yet and my agent says couldn't find out at the time because it hadn't closed. I should ask her again since it's obviously closed now.

I finished reading his 'diary' on the Atlanta home and his rental. I admit I don't remember half of what was presented but it was detailed and I liked it because I too am detail-oriented and could follow what he was writing. I had no idea the multitude of things that went into rehab/new build.

But I digress.... this is about determining if this property would be a good buy/hold knowing the rehab that needs to be done and of what "legal" :) creative financing I can do on it. :-)

@Daria B. a refinance is not considered income. You only have a taxable event when you sell the property. Financing does not play a role.

Hope that helps.

You need to take a slightly different view. The rehab costs for a new rental have to be considered part of your acquisition costs; after all, until a rental is placed in service all costs are capitalized and depreciated over time. So with that perspective, the rehab costs (both materials and labor) are part of what you pay to "buy" a rental in good condition, ready to rent. Because you will have some difficulties in the rehab (rehabs always seem to have something that makes for difficulty), and because you will have to invest more time and effort to make it ready for rent - those factors have to be used to justify your discount amount. Only you can say how much discount you must get, but because if you had to sell soon after the rehab was completed you'd have closing costs of about 10% you need at least that much discount; if you sold to an investor, they look to buy at 70% or less of value so you'd need a bigger discount. 

That's correct your sale price plus all your rehab costs  = the price of the buy. 

So this house is going to cost you $100,000 if there aren't additional rehab costs.  You probably will end up needing the new windows.   It sounds like the bathroom might need more then you are figuring and we don't know what to figure for the garage foundation.  I imagine the landscaping will add some cost.  So if the house ends up costing $110,000 it's still probably OK for cash flow.

It seems though you have pulled this $60,000 number out of a hat?  It's 1/2 of what they are asking.

Hi @Barbara G. and @Steve Babiak

Thanks for your input.

No, I didn't pull the number out of a hat - it just happened to be half of what they are asking. 

I looked at sales comps (major contributing factor) and "what's being offered up to sell" (thought not the major contributing factor).

From there I went through the property, and yes landscaping was not factored in and will need tree cutting. Because the rest is in decent shape, I am doing the lawn mowing. There really isn't much there.

After coming up with my "list" of things $$$ that need to be fixed, I deducted that from what the recent sales comps were. I just  looked up sales and found one that is the lowest qualified sale for $172k (june/2015). When I looked before it was in the $130-$140 range, which was prior to june. When we looked at it we figured it would sell if fixed up at $130.

I'm thinking because of the condition people don't want to mess with it - still I know there is something amiss on the back wall of the garage (concrete).

Due to the labor I have no idea on; I do on some things, I padded a %. I've been through kitchen, windows, roof, painting, and bath upgrades before.

I priced doors and reduced from what I had been through before since those projects (in the same city) were more cost (kitchen in my other rental is larger than this kitchen). Also, I would not be doing higher end material in the subject property.

I did not factor in the closing costs - good point.

The bottom line when I  looked at this at 129k (their offer and not what it's worth to me having to do rehab), even if I offered 120k without rehab, it is not desirable. With an estimation of rehab, let's say for sure it was $30k, this does not cash flow at all. That's a $150k house with max rent being $1300. When I run numbers on that knowing the tax, ins, r$m, capx (although the rehab takes care of this I still grant a small 5%), PM fee, and landlord license that is also yearly there is no profit.

If someone were buying the house to live in and rebah it, it would be a steal at that price. But for rental, it's not. So my "discount" as you say, I started with ARV - rehab costs - holding costs. So $60k may be a little lower than applying more actual costs.

But here in lies the problem I'm trying to determine....purchase offer and rehab costs.

Originally posted by @Barbara G. :

That's correct your sale price plus all your rehab costs  = the price of the buy. 

So this house is going to cost you $100,000 if there aren't additional rehab costs.  You probably will end up needing the new windows.   It sounds like the bathroom might need more then you are figuring and we don't know what to figure for the garage foundation.  I imagine the landscaping will add some cost.  So if the house ends up costing $110,000 it's still probably OK for cash flow.

It seems though you have pulled this $60,000 number out of a hat?  It's 1/2 of what they are asking.

 If it ends up at $110,000 as an offer then for cash flow this still mean an offer much lower that still needs to include rehab costs.

Originally posted by @Steve Babiak :

You need to take a slightly different view. The rehab costs for a new rental have to be considered part of your acquisition costs; after all, until a rental is placed in service all costs are capitalized and depreciated over time. So with that perspective, the rehab costs (both materials and labor) are part of what you pay to "buy" a rental in good condition, ready to rent. Because you will have some difficulties in the rehab (rehabs always seem to have something that makes for difficulty), and because you will have to invest more time and effort to make it ready for rent - those factors have to be used to justify your discount amount. Only you can say how much discount you must get, but because if you had to sell soon after the rehab was completed you'd have closing costs of about 10% you need at least that much discount; if you sold to an investor, they look to buy at 70% or less of value so you'd need a bigger discount. 

At all consideration I would want to hold onto the property. Otherwise, it's getting into the flipping business and that consideration is a lot more than I want to take on now. I am looking at this to hold in my portfolio. The issue at hand is that rehab holds true for flipping or holding. It's the consideration of doing the rehabbing and determining what numbers will work for an offer and rehab that will still cash flow. My humble opinion. :) At some point I was bound to stumble upon this - most properties I look to be 90% move in and get at a good price. Much like that REO - it's someone else's pending now.

With rehab like this I have to factor in much more - and still come out the other end cash flowing. The area is a solid rental and people are scooping up properties left and right. I offered on one but the owner was unacceptable of the offer - she took someone else's just slightly higher and it probably works for their numbers. They appear to be doing all the work - I have to have a GC to get this work done. That's also a difference in investors - some can save by doing and others don't have that option.

@Daria B. Have you tried the spreadsheets and calculators available on the site?

That should help you understand the numbers better and prevent you from overlooking expenses (like closing costs, etc.)

Originally posted by @Seth Carlone-Hanson :

@Daria B. Have you tried the spreadsheets and calculators available on the site?

That should help you understand the numbers better and prevent you from overlooking expenses (like closing costs, etc.)

 Yes, I've used them. Thanks

Originally posted by @Daria B. :
Originally posted by @Steve Babiak:

...

 At all consideration I would want to hold onto the property. Otherwise, it's getting into the flipping business and that consideration is a lot more than I want to take on now. I am looking at this to hold in my portfolio. ...

You missed my point. Life happens, and in unpredictable ways. So today you intend to hold it, but some life event forces your hand so you have to sell. Selling at a loss would be something you'd not enjoy, especially when your situation has become one where you must sell. 

Originally posted by @Steve Babiak :
Originally posted by @Daria B.:
Originally posted by @Steve Babiak:

...

 At all consideration I would want to hold onto the property. Otherwise, it's getting into the flipping business and that consideration is a lot more than I want to take on now. I am looking at this to hold in my portfolio. ...

You missed my point. Life happens, and in unpredictable ways. So today you intend to hold it, but some life event forces your hand so you have to sell. Selling at a loss would be something you'd not enjoy, especially when your situation has become one where you must sell. 

 Ok, I see yes, I did miss your point. Thanks

This is great practice in the BRR (buy, rehab, rent -no last R - no refinance @Daria B. ?) strategy theory, but probably not much more.  I don't see listed property selling for 50% of asking much these days, especially if it's a nice round number.  I would at least make my offer sound like I applied the sophisticated analysis that you are doing and make is $60,461 or something.

In general I have found material costs to be about 40% of total job.  I would guess labor to be 150% of material costs, essentially.

In general I try to recoup my fix-up costs in 3 years on rentals.  Updates in 2.   Either way, I don't do a ton of work to any property without it being a significant value play.  If I'm going to break even, I'd rather take a nap.  Good luck and please keep us posted!

Originally posted by @Steve Vaughan :

This is great practice in the BRR (buy, rehab, rent -no last R - no refinance @Daria B.?) 

  1. knowledge has no bounds - thank goodness - :)

strategy theory, but probably not much more.  I don't see listed property selling for 50% of asking much these days, especially if it's a nice round number.  I would at least make my offer sound like I applied the sophisticated analysis that you are doing and make is $60,461 or something.

In general I have found material costs to be about 40% of total job.  I would guess labor to be 150% of material costs, essentially.

  1. this is where I'm falling short of actual labor cost. trying to determine and put as part of my numbers. Material is not so bad.

In general I try to recoup my fix-up costs in 3 years on rentals.  Updates in 2.   Either way, I don't do a ton of work to any property without it being a significant value play.  If I'm going to break even, I'd rather take a nap.  Good luck and please keep us posted!

  1. and this is the question that has surfaced as well - how do I know it's a good buy and determining what my recapture is going to be - x years from now. I came up with: $20k rehab / $145 cash flow = mo to recapture (137) / 12 = yr to recovery (11). Not sure but that's my math....

There is often a gap in the market between what a flip strategy requires to be profitable and and buy and hold.  I prefer to buy my properties needing a little something, they tend to go at a discount.  The home owners think it is ugly and the flippers can't make anything on it.  Creates a nice opportunity gap.  

As far as your pricing, taking the comps and subtracting what it takes to make the property similar to the comped property.  Is a flawed approach.  You can not make a straight line assessment like that.  Sometime a deal works and sometimes it does not.  Unless the market supports the price, I would not advise my clients to offer 50% off the listing price.  You are going to insult them and they will most likely not even respond.    At that level, you are in the wholesale market of, "my hair is on fire" and I need to get rid of the property today.

What are comparable properties selling for that do not need all of the repairs you are describing?  If you are "all in" at $110K after repairs, how much equity will you have?

Is this a bank owned property, or normal sellers?  If normal sellers, you are going to have a hard time getting someone to accept 50% of list price unless they are truly desperate.

Originally posted by @Lesley Resnick :

There is often a gap in the market between what a flip strategy requires to be profitable and and buy and hold.  I prefer to buy my properties needing a little something, they tend to go at a discount.  The home owners think it is ugly and the flippers can't make anything on it.  Creates a nice opportunity gap.  

As far as your pricing, taking the comps and subtracting what it takes to make the property similar to the comped property.  Is a flawed approach.  You can not make a straight line assessment like that.  Sometime a deal works and sometimes it does not.  Unless the market supports the price, I would not advise my clients to offer 50% off the listing price.  You are going to insult them and they will most likely not even respond.    At that level, you are in the wholesale market of, "my hair is on fire" and I need to get rid of the property today.

I know a lot of people say offer what you think you want it doesn't matter what others think. I've often seen others speak of offering 30k less than list and describing the look from the agent/seller as "gastly".

I'm of the mine set that I'm trying to learn "how" to best structure a deal. I've also seen a lot of properties sit for months on end and finally get to a price that I would have offered before all those months passed - and they sell at that much lower price.

Please then enlighten me on what you say is a "flawed" approach. I've been asking "how" do I go about getting an offer price - one gentleman gave me his take on this earlier and I'm looking at just how to get to a price. Why is a flip that uses ARV ok but not a rehab that will be kept as a hold?

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