Remember that high school movie where the homely girl was transformed into the beautiful prom queen when she removed her glasses and put on some makeup?
(Yeah… me neither. I was watching Die Hard.)
The point is this: Human nature loves to see transformations. We love to see the before and after and marvel at what it must have taken to get from A to B. Just tune into any episode on HGTV to see what I’m talking about.
For this reason, people love to buy fixer-uppers. But is this always a good idea when investing in real estate? Should you invest in a fixer-upper when getting into rental properties? Let’s find out.
(We interrupt this regularly scheduled blog post to invite you to this week’s BiggerPockets Webinar! If you are new to real estate, don’t miss this live webinar! Click here to sign up for How a Newbie Can Start Building Wealth Through Real Estate.)
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.
What Is a Fixer-Upper?
First, let’s all get on the same page as to what I’m even talking about when I use the term “fixer-upper.”
A fixer upper is a home that needs either minor or significant rehabilitation before it can be used for its intended purpose. This could refer to both a “house flip” or a “rental property,” but I’m mostly going to focus on the rental side. The repairs a fixer-upper can need range from light cosmetic work, such as fresh paint or new carpet, to more intensive renovations, such as a new roof, foundation, plumbing, or electrical.
I actually love investing in fixer-uppers. In fact, I’ve never purchased a property that didn’t require some level of rehab to get it to a rentable condition.
For me, it has just made sense.
On the 44th episode of the BiggerPockets Podcast, Michael Woodward tells a story about taking his kids to look at potential houses to buy. Michael mentions that when they walk into a house with an absolutely terrible odor, he turns and asks his kids, “Boys, what does that smell like?” In unison, they shout, “Money!”
What this cute story represents is often the truth with fixer-uppers: There can be money in the mending, riches in the restoration, freedom in the fixing!
At the same time, fixer-uppers do carry a large degree of risk and can turn your investment into a money pit. So let’s examine both the pros and cons of buying a fixer-upper.
Pros of Buying a Fixer-Upper
Finding good, nice homes can be tough in a crowded market because everyone is looking for a nice house. This is especially true in the single-family space, where you are competing with owner-occupants for properties. People don’t want to buy a project; they want to buy a home that is move-in ready.
The same is often true for multifamily properties. Investors don’t usually want to buy a problem; they’d rather buy something that is easy to simply purchase and rent out. Therefore, when you invest in a fixer-upper, you clear out the vast majority of the competition because most people simply do not want to do the work needed to bring a home up to par. Instead of competing with 100% of the population, you are competing with perhaps 10% of those who are willing to look at fixer-uppers. This can make finding a deal much easier, even in a hot market.
I also love fixer-uppers because you can build some immediate equity in the property through a concept known as “forced appreciation.” Appreciation is the concept that properties tend to gain value over time. But what if I wanted to shorten that time? What if I didn’t want to wait 20 years for inflation to push my property value up?
While it’s very difficult to raise the value of a nice home, it is possible to raise the value of a fixer-upper and take advantage of this amazing wealth generator called appreciation.
For example, three years ago, I purchased my own primary residence for $62,000, and it was a fixer-upper. It needed paint, flooring, some foundation work, new windows, new counters, and a whole lot more. I ended up putting about $20,000 worth of work into the property, so I currently have approximately $82,000 in the home. However, the home is not worth $82,000. As soon as I finished the rehab, it became worth what other fixed-up homes of its size and condition are worth in my neighborhood—about $132,000. So I was able to raise the value of the home from $62,000 to $132,000 through just the power of the rehab.
Now I will be able to take further advantage of that great wealth generator we call appreciation (which is guided by inflation and the real estate market) from a starting point of $132,000 rather than $62,000. In other words, if the market appreciates 2% per year, it’s going up 2% from $132,000 (to $134,640 next year, $137,333 the following year, $140,079 the following year, and so on). My wealth creation was supercharged through the power of buying a fixer-upper.
Potentially More Cash Flow
Because fixer-uppers allow you to buy a property for far less than other properties in the area, a fixer-upper can also help you achieve greater cash flow.
To illustrate what I mean, let’s return to the story I just shared about my own primary residence. Had I purchased this home for the full value of what it was worth, my ability to earn any cash flow from the property would have been severely diminished because my mortgage payment would have been much higher. Instead, my mortgage is cheap enough that if I rented the home out today, I would be renting it for what a $132,000 house would rent for, but I’d only be paying a mortgage on an $82,000 house (because I refinanced to a $82,000 loan, getting all my rehab money back!).
Therefore, my cash flow is also being supercharged because I bought a fixer-upper.
Unique Financing Options
Finally, one of the reasons I like fixer-uppers so much is the unique financing ideas it can offer. I’ll also discuss financing in the “cons” section for fixer-uppers, but let’s first talk about how fixer-uppers can lend themselves to greater financing options.
Although most lenders do not lend on properties that need a lot of work, I’ve found a unique way to invest in fixer-uppers that allows me to ultimately get the rental property for very little of my own cash. To accomplish this, I find a great deal, get a private lender or hard money lender to finance the purchase (and hopefully the rehab), and then, after a “seasoning” period of six to 12 months, I refinance the home into a long-term mortgage. I call this the BRRRR strategy (for buy, rehab, rent, refinance, repeat).
I recently accomplished this with the purchase of a five-plex in my town. The property was listed at $120,000 (and had been reduced from a starting price of $150,000). I offered the sellers (a local bank) $90,000 for the property, and they accepted. The property needed about $10,000 of work (mostly interior and exterior paint, some carpet, and some cleaning). To fund the purchase of this property, I called a friend I’d met on BiggerPockets who I knew lent money to individuals for short-term rehabs. He agreed to fund the entire $90,000 purchase price if I funded the rehab costs. A little over one year later, I went to a local bank and refinanced (obtained a new loan) for $90,000 to pay off my friend from BiggerPockets. In the end, I have about $10,000 invested in this deal, with cash flow of $800 per month and have about $60,000 of equity built into the property. All this was made possible because it was a fixer-upper.
Now, before you go out and buy a fixer-upper because of what I’ve just said, let’s talk about some of the dangers, risks, and disadvantages—because there are many!
Cons of Buying a Fixer-Upper
Any time you open up a wall, rip up a floor covering, remove part of the roof, or undertake another rehab project on a fixer-upper, you increase the risk of finding more that needs to be fixed. For example, you might decide that you need new cabinets, but suddenly you realize that you also need new electrical work in the wall behind those cabinets. Maybe you’ll discover some lead-based paint. Maybe you’ll find rotten wood. The point is this: It’s very difficult, especially as a new investor, to accurately estimate the total cost of rehab on a project.
Rehabbing a home is usually not a peaceful experience. From the first swing of the hammer to the final change of the locks, dealing with the drama associated with rehabbing can be stressful. If you plan to do the work yourself, expect to come home each day with cuts, bruises, and a lot of frustration. If you plan on hiring it out, anticipate dealing with contractors who say one thing and do another, show up late, and miss deadlines. As you get more proficient at rehabbing a home, it can become an easier task, but learning how to efficiently rehab a house takes time.
Potentially More Out-of-Pocket Costs
Because of the two items I mentioned earlier, maintaining your budget while rehabbing a home is difficult. The same applies for maintaining your timeline. Therefore, when investing in fixer-uppers, it’s easy to spend more money than you planned and for the project to take longer, thus throwing your analysis out the window. This can affect your ROI and turn a great deal into no deal at all.
5 Questions to Ask Before Investing in a Fixer-Upper
So should you invest in a fixer-upper?
Despite the cons I outlined, I would say yes, you should definitely consider it because of the overwhelming pros. However, before you jump into your next project, ask yourself these five questions about the deal.
How Bad Is It?
There are many levels of severity when dealing with fixer-uppers. Some properties need just a few thousand dollars’ worth of paint, while others need a complete overhaul. As common sense would suggest, the less work a property needs, the less risk you’ll have that something will go wrong during the rehab. At the same time, however, the less work a property needs, the more competition you’ll face. This is why I generally look for properties that appear to need a lot of work to the general public but that actually just need minor fixes.
For example, homes that have a bad smell because of pets or cigarettes are a prime candidate for me because smells are easy to rectify. An ugly exterior paint job or a bad roof are also fairly easy (if costly) to remedy, but they scare away most potential homeowners. So, before you buy a fixer-upper, I encourage you really look at the property and have an accurate estimate of what it’s going to take to fix it up. Don’t go into a fixer-upper blind.
Is It Worth It?
Let me ask you a question: Is it better to buy a house for $120,000 that needs $30,000 worth of repairs or a house that is $150,000 that is 100% finished? With all other factors being equal, the finished house clearly has the advantage. However, many investors fail to comprehend this logic and instead think “fixer-upper” automatically means “great deal.” It doesn’t! Often, the cost of rehabbing a project will negate any discount you might get. On the other hand, if you could get that same property for $90,000 and put $30,000 into it to make it worth $150,000, now we’re talking!
Do I Have the Time?
Whether you plan to do the work yourself or not, fixer-uppers take time! You have to be present at the property often to make sure the work is being finished correctly, or maybe you’ll end up having to do the work yourself. I have a friend who bought a fixer-upper triplex with plans to live in one unit and rent the other two out, but it took him three years to fix up the two other units and get them rented! While this friend may still have a great investment on his hands, he lost close to $40,000 in potential rent over those three years because he didn’t have time to handle a fixer-upper.
Do I Have the Skills?
Most people who are looking to get started with fixer-upper rental properties plan to do the work themselves. I actually encourage this, as long as the work is on a small scale. Being able to do your own rehab can save you a ton of money and can help you get a good feel for how long projects take so you can better manage the hiring out of those projects in the future. However, if this is your plan, do you really have the skills to take on the project? If not, see the next question in this list.
Do I Have the Drive?
Or more importantly, do you have the mental skills and motivation needed to learn how to accomplish those projects? My first home was a fixer-upper, and I had never swung a hammer in my life! However, I picked up a book on home improvement and began learning on the job. I also called in a lot of favors from other people I knew and had them teach me how to do things. By the end of the project, I could install carpet, tile a bathroom, lay laminate wood flooring, solder copper pipes, and fix a leaky roof—not because I had the skill, but because I had the desire and motivation to learn.
By answering these five questions for every project you are about to take on, you can better decide whether it is the right path for you.
Fixer-uppers can be a great way to supercharge your wealth creation, but they also present increased risk. Just be sure to do your due diligence on any fixer-upper you plan to buy, and accurately account for the hurdles you might face. Then take action, and get a little dirty!
Are fixer-uppers a part of your real estate portfolio? What advice would you give to others who want to start rehabbing property?
Let’s get a conversation going in the comments section below!