Recently, I had a tenant move out of one of my townhomes, and I decided to fix it up in order to sell it. I had owned the property for a while, and the area was starting to change. With taxes, township rental license fees, and inspections on the rise, the cash flow just wasn’t what it used to be.
Sure, I had entered originally entered this deal with the intent to keep it as rental, but sometimes you just have to shift strategies.
When it comes to the type or scale of the rehab, a lot depends on your exit strategy.
How to Invest in Real Estate While Working a Full-Time Job
Many investors think that they need to quit their job to get started in real estate. Not true! Many investors successfully build large portfolios over the years while enjoying the stability of their full-time job. If that’s something you are interested in, then this investor’s story of how he built a real estate business while keeping his 9-5 might be helpful.
Scale of the Rehab
When fixing up a property to sell, whether it’s a new property or an existing rental, the cost is usually more than if you’re fixing it up just to rent it out.
With a rental, the focus is more on functionality. If things are just a little outdated, it may only make sense to replace them once they’re completely worn out.
When fixing up a property to sell it, it may make sense to upgrade a lot of the features in order to move the property quickly and for a good price.
Rehabbing to Sell
But, when you’re fixing up to sell, how fancy do you get?
For example, do you use some two-tone paint or custom colors in the kitchen and bath, or do you use all one color, which is more common in a rental property? Do you upgrade some of the electrical fixtures or the flooring (with tile or nicer carpet), instead of using your go-to fixtures and flooring for a rental property that costs less or that can handle more wear and tear?
Another big question is how far do you go in upgrading certain parts of the house (whether that be the kitchen, bath, basement, or even the garage)? After 30 years as a real estate agent, I learned that if you can show the buyer a nice kitchen and bath, the deal is usually done. It’s a huge selling point.
Related: 4 Painful (But Invaluable) Lessons Learned From a Rehab Gone Wrong
The other thing to remember, though, is that you don’t want to over-improve for the area. It may even make sense to check out your competition by going to see some of the other homes for sale or rent in your property’s surrounding neighborhood.
Cons to Selling
Probably the biggest con to fixing up a rehab to sell it is the taxes, more specifically the short-term capital gain tax, which applies if the house sells and settles in less than one year after you bought it. For example, if you are able to own it for a year and a day, your taxes would be cut approximately in half since the profit on the sale would now be a long-term capital gain. Unfortunately, we all have this silent partner in the house flipping business, and his name is Uncle Sam.
Also, what happens if the property you fixed up isn’t selling, even after you’ve tried many incentives, which don’t seem to work? In my area in the Northeast, if you don’t sell by Thanksgiving, you have a good chance of sitting on the property through the winter, including paying for the heat and snow removal, until the spring market reappears.
This happened to me once, and I was forced to rent it out, as well as run the risk of the new tenant messing up my really nice house that had been renovated to sell.
Rehabbing to Rent
Fixing up a property to rent it out may be a little less expensive, but it comes with its own set of concerns as well.
For instance, it may be hard to refinance the property when completed. Banks usually like to see a property that’s passed all the code inspections and is rented to a good tenant with at least a one-year lease.
Some other problems you may encounter could be the loan-to-value they’ll allow or the possibility of a higher interest rate since it’s a rental property, and you also run the risk of getting a low appraisal on the after-repair value.
Another thing to remember is that now you’re dealing with tenants and/or a management company, too.
Many successful real estate investors try to get around this management and maintenance piece by selling the property on a rent to own basis instead of just keeping it as a normal rental. This way, they’ll have lower taxes upon the sale since it’s been over a year.
Also, the tenant would likely have more of an owner’s mindset while living in the property and would usually be responsible for minor repairs and upkeep. This is where the lease option strategy could be most effective, and it could be a way for the real estate investor to stay out of the repair business, too.
But the worst case scenario is where you fix up the property to sell, and it doesn’t sell or rent. Now you’re potentially in trouble since you have no cash flow coming in at all.
That is why timing is so important. Of course, you should have your exit strategy in mind before you enter the deal, but you should also know the market and be prepared to shift strategies if necessary.
For me, I prefer the “fix and flip after a year and a day by selling on a lease-option” strategy, but I’m also interested to hear what strategies other folks on BiggerPockets would employ.
Which do you prefer, fix to flip or fix to rent, and why?
Leave your comments below!