Preparing to Rehab
Before purchasing an investment property, you must take essential steps, particularly one you plan to rehab. For that reason,
STEP 1 in SMART Rehabbing is Preparing to Rehab.
It is all about gaining knowledge before purchasing an investment property to rehab to help you BUY RIGHT. Preparing to Rehab topics include Knowing Your Market, Building Your Dream Team, Finding a House, Calculating What to Offer, Understanding ARV, Evaluating and Budgeting Quick Repair Costs, Choosing Your Exit Strategy, Funding and Completing and a Home Inspection:
Knowing Your Market: Before you invest in a property, you need to research the markets of interest and choose where you’d like to focus your efforts. If you are new to investing, we suggest starting within an hour of where you live. Also, know that size matters. Bigger markets are typically better than smaller markets (look for areas with populations over 100,000). Information including census data, local industries, city population and growth rates, employment opportunities, local attractions, and the quality of schools in the markets you are interested in are examples of some important considerations in market selection. You will want to know if the area is investor-friendly. Also, determine common and desired features among homes sold (for example, the typical number of bedrooms and bathrooms and whether homes have attached garages). What is the average price paid? How long does it take on average for a home to sell? There are many resources available for you to learn about the markets you are interested in. Remember, in real estate, LOCATION MATTERS. Get a map, drive the neighborhoods, and follow and read the local news. Invest the time to learn about the markets you are interested in and wisely choose your market(s).
Building Your Dream Team: Real Estate investing is like a team sport. You must always be looking for and adding talent to your team. Surround yourself with the right people. The essential team members include a realtor, contractor, home inspector, appraiser, investor-friendly attorney and accountant, title company, insurance company, roofer, plumber, electrician, handyman, money lenders & property management. Know that building your dream team is an ongoing process. As you add team members, be sure to check reviews and always ask for references.
Finding a House: There are many ways to find houses that may be of interest to you. Realtors have access to the MLS (multiple listing service) for on-market opportunities. You can request to be set up with a daily update of properties that meet your specific search criteria. In addition, you can use resource websites like zillow.com, trulia.com, redfin.com, auction.com, and craigslist.org, to mention a few. Wholesalers and other investors can bring you opportunities. You can proactively be implementing your marketing efforts, including direct mail marketing, driving for dollars, door knocking, social media, ads, print, flyers, bandit signs, to name a few. You are looking for motivated sellers. Make sure you have a business card with your name and telephone number on it. Let people know what you do – that you buy houses – and share your business card so they know how to reach you.
Calculating What to Offer: You will need to know a few essential terms and formulas when calculating what to offer on a property.
MAO is the Maximum Allowable Offer: the most you can pay for the property of interest
ARV is the After Repair Value: what you would expect to sell the property for after it is repaired
Repair Costs: the estimated cost to make all repairs/improvements to the property to increase its value and profitability
(ARV * 70%) – Repair Costs = MAO
- Example:
If a property of interest has an ARV of $400,000 and repair costs of $50,000, what is MAO?
($400,000 * 70%) – $50,000 = MAO
$280,000 – $50,000 = $230,000
In this example, the maximum allowable offer is $230,000.
Understanding ARV: As noted above, ARV is the After Repair Value. It is the most important number to understand BEFORE you make an offer to buy a property. Without understanding the ARV, how could you possibly buy-right? The ARV is what you would expect to sell the property for after it is repaired. It is determined using comparable SOLD properties. Comparable properties or “comps” must be an apples-to-apples comparison. They should be within one (1) mile of the property you plan to rehab. They should have the same number of bedrooms and bathrooms, the same style construction, the same type of garage, and living space of same/similar square footage +/- 10%. They should look like what your rehabbed property will look like. Comparable properties should ONLY include properties SOLD in the most recent ninety (90) days. You will want to see at least four (4) comparable sales. Your comparable properties should NOT INCLUDE active or pending listings. This information is available on the MLS and can be provided by a licensed realtor.
Evaluating and Budgeting Quick Repair Costs: The initial evaluation of a property includes doing an Assessment Walkthrough and preparing Quick Repair Costs. Your Assessment Walkthrough is set up to see the property’s condition firsthand and determine what needs to be repaired or replaced. This walkthrough is an opportunity to take measurements of all rooms. Take lots of detailed pictures and record a video of your walkthrough, pointing out EVERYTHING that you feel may need repair or replacement. This detailed information will make the Quick Repair Costs and execution of your exit strategy easier. Remember, you plan to determine what needs to be done and how much it will cost for this property to look like your comps used to determine your ARV. To avoid leaving out important details, we suggest using a standard Assessment Walkthrough Worksheet so that you can collect all information in one place with a repeatable system. Practice makes perfect. If you’ve not done this before, you might consider bringing a contractor with you – ensure it is someone you trust.
Once you’ve completed your assessment walkthrough, you are now ready to determine what level of rehab is needed based on the property and your planned exit strategy. There are three levels of rehabbing considered for calculating Quick Repair Costs: Lipstick, Standard, and Upgraded. Choose the level of rehabbing that best fits.
Lipstick Rehab: This is a simple rehab and typically completed at Rent Grade. It does not require significant work, perhaps painting, replacing carpet, fixtures, appliances, countertops, etc. You are rehabbing to ensure that things are in working order, clean, and are livable for a future tenant of the property. The cost for a “Lipstick Rehab” is typical $15-$18/sq ft.
- Example:
If the property you have evaluated is 1,200 sq ft, and will need a Lipstick Rehab, the QUICK REPAIR COST calculation is: 1,200 * $15-$18 = $18,000-$21,600
Standard Rehab: This is more involved than a Lipstick Rehab and is typically a nicer finished home. It can include installing new hard surface flooring, remodeling bathrooms, and replacing items such as an air conditioner or roof. The cost for a “Standard Rehab” is typically $20-$25/sq ft.
- Example:
If the property you have evaluated is 1,200 sq ft, and will need a Standard Rehab, the QUICK REPAIR COST calculation is: 1,200 * $20-$25 = $24,000 – $30,000
Upgraded Rehab: This is the next level of rehab. At this level, you are adding nicer finishes such as travertine stone flooring, stainless steel built-in appliances, crown molding, etc. This is more typical for a property that will be flipped or held as a higher-end vacation rental. The cost for an “Upgraded Rehab” is typically $35+/sq ft.
- Example:
If the property you have evaluated is 1,200 sq ft, and will need an Upgraded Rehab, the QUICK REPAIR COST calculation is: 1,200 * $35+ = $42,000+
Choosing Your Exit Strategies: When you purchase a property as an investment, there are four key exit strategies that you will choose between. Having more strategies gives you more options and gives you more flexibility on the level of rehabbing that you might need to do. A common mistake among new investors is over or under rehabbing a property. Make sure your rehab plans and budgets are aligned with your intended exit strategy.
Wholesaling: When using wholesaling as your exit strategy, you will assign the contract to another investor. This investor will purchase the property and make any repairs needed to improve and increase the property’s profitability – not you, the wholesaler. NOTE: While wholesaling does not include the need to rehab, it is beneficial for Wholesalers to know what their buyers are looking for (the market & type of property) and to thoroughly understand rehabbing expenses so they can account for those expenses AND their target assignment fee when making an offer to the seller of a property.
Lease Option: When using lease-option as your exit strategy, the amount of rehab will depend on the property’s condition, the location, and what might be done to increase the value and profitability of your deal.
Buy and Hold for Rent: When using buy and hold as your planned strategy, rehabbing will depend on the property’s condition, the location, and the type of rental property (for example, long-term tenant vs. short-term vacation rentals like Air BNB or VRBO).
Buy, Fix and Resell (FLIP): When using the buy, fix and flip strategy, rehabbing will depend on the property’s condition, the location, and what improvements will increase the value and profitability of the property when sold to a retail buyer. This is the most widely known and utilized exit strategy for rehabbed properties.
Funding: The purchase of a property requires financing. The average consumer is taught that purchasing a property requires having cash on hand or qualifying for a bank loan (mortgage). However, in real estate investing, we learn there are many creative funding options available.
Yes, cash and bank loans are an option. However, those options alone can be limiting to the growth of your business. Expanding your funding resources to include creative finance options like OPM (Other People’s Money) is imperative. As you get started, you will want to build a list of potential funding sources. Here are just a few OPM ideas to get you started with making a list of possible funding options for your real estate investing: Owner/Seller Financing, Family & Friends, Private Money, Hard Money Lenders, Joint Venture Partners, Real Estate Crowd Funding. You may also consider utilizing tools like a Self-Directed IRA, 401K Loan, and Life Insurance Policy Loan. With all financial decisions and real estate transactions, we recommend that you first seek the advice of a local professional to ensure the proper structuring of any agreements you enter.
Home Inspection: A home inspection is a professional, third-party inspection of a property you intend to purchase. Hiring a home inspector is not done until you have the property under contract. Home inspections typically cost between $350 – $500, and they must be completed within a specified timeframe based on your contract terms. Be sure to hire someone who has a solid reputation for providing a thorough inspection and a very detailed inspection report. You are hiring a home inspector to evaluate the home from a structural and safety standpoint to ensure you are buying a hazard-free home, up to code, and is genuinely the investment you believe it to be. Home inspectors report on the hard-to-reach places like the roof, crawl space, and attic. Good inspectors can help identify expensive repairs before you buy the property, which can save you money. Home inspections are not required. However, there are few cases where you would want to forgo one.