How to look at rehab as an investment

3 Replies

I would like to know what is the equation, or metric that I should use to judge one potential project vs another in terms of cost and the potential increase in revenue that money should create. For example I have a 3/2 SFR that has an unfinished basement, if I spent 15k to finish it and added a bedroom and a full bath to bring in another $250 a month in rent. Or if I added A/C to the same unit for 4K and that got me $50 which is better? Now I know that that equation is pretty easy and it’s just a ratio of income/dollars spent, but the harder question is......should I do either? What I’m having real trouble with is if my property has a 5.0% cap rate now, how do I factor the cost of these projects into that? And if either of these don’t improve the existing cap rate then maybe they are not the right project for this specific project? Help me wrap my head around this a little more, thanks!

Hey @Bryan Cork

My mentor always went for a payback period of 3 years (36 months) for improvements to be worth it. If payback was bigger than 40 month he never did it.

Put another way, he'd invest $1,000 if it boosted rent $30/month. That's strictly a cashflow mentality since he seldom assumed appreciation.

Colorado is experiencing major appreciation, so you could lower your payback standards since your profits would come from appreciation.

Finishing the basement: Assuming $15,000 to get an extra $250/month, that's a payback of 60 months or 5 years. It's personal preference, but I wouldn't do it.

Adding A/C: Assuming $4,000 to get an extra $50/month, that's a payback of 80 months, almost 7 years. Again, personal preference, but an even worse idea (cashflow-wise) than finishing the basement.

I think the best way to evaluate an additional investment is "Return On Investment".  

Your bed/bath example yields you a 20% Return on Investment ($250 x 12 / $15k).

Your A/C example yields you a 15% Return on Investment (($50 x 12 / $4k). 

Both of these would be decreased by vacancy rates, but they are both pretty good.

So the question is "do you have other investment opportunities that would yield you a higher return on your money?"

If you do then take them.  If you don't then invest in the bed/bath.