I typically buy distressed properties. I find that distressed properties are the key to getting a deal and adding value. Typically, these properties need major rehab work. I used to think that the rehab job was complete once tenants moved into the property. Not anymore. Tenants cause previously unknown, hidden problems to make themselves known.
The thing about distressed properties is that the previous owner let them get into a distressed mode, which usually does not happen overnight. He likely only patched what should have been replaced and “kicked the can on down the road” so to speak with necessary repairs. Eventually, after having kicked the can enough times, the property begins a vicious cycle downward of more deferred maintenance and vacant units to short sale, tax sale or foreclosure.
When viewing a distressed property, you can see all of the cosmetic repairs that are needed. Things like new paint, tile, kitchen and bathroom fixtures, etc. But there are a lot of things you cannot see such as plumbing, sewer lines, electrical lines, etc. All of that stuff behind the walls and under the ground
Sometimes the problems will show themselves when the utilities get turned back on and your contractors begin work. You can hear water running, find electrical outlets that do not work, etc. You can get those problems resolved.
But sometimes a problem will not show itself until the systems are used to their full capacity. For example, your rehab crews are simply not going to use the plumbing system to its full capacity. The plumbing system will not get used in that manner until after the tenants move in and start taking showers, washing dishes, etc. Only then will you find out that the sewer line is broken or a water line was taped up. Only when the tenants have plugged in all of their gadgets will you find that the electrical system was crossed from one unit to the next. So the rehab job is not really done, until after those first tenants move in and give the systems a real test.
How to Estimate Rehab Costs!
Estimating rehab costs accurately can make or break your real estate business, and it takes years of experience for even the best rehabbers to master the art. However, you can expose yourself to less risk and get more accurate with your projections by learning how the pros think when estimating construction costs.
Three Ways to Handle the “After-Rehab”
What can you do to protect yourself? First, give everything the best look over you can. But trust me, even then you cannot and will not see everything.
Second, be sure to have some “oops” in your rehab budget and save some of that past the rehab “completion.” Things are going to pop up. Depending on the nature of the property, the “oops” may be as high as 50% of your projected rehab costs.
Third, we always tell our tenants that we have just fully rehabbed the property and they are the first to live in it. We explain that we believe everything is working well but we do not know until they fully use the systems. If a problem does arise, we ask them to let us know so we can fix it as soon as is possible. Almost all are very understanding about this and it helps us work with them when these problems arise. Plus, it builds rapport as we quickly make the repairs.
So in closing, do not expect your rehab to be complete when the tenant moves in. Instead, expect there to be a few more fixes (sometimes big ones) once the all of the property’s systems get fully utilized.