After completing well over 100 renovation projects ranging from $20,000 budgets to budgets near $1,000,000, I have learned a few things about estimating costs. I have learned that it is really easy to under budget. Even with the experience that I have gained, I tend to under budget vs. over-budget. Over the past several projects, I have been diligent with having enough in the contingency budget, so that we don’t get stuck in a bad spot. It is so easy to forget some of the little stuff or not think about the behind the walls items. A few mistakes here and there can lead to a disastrous result.
When going about trying to figure out the cost of the renovation, you will need to figure out what you will need to do to improve the house to the market standards. You don’t want to under improve and you certainly don’t want to over-improve. The tricky part about the budget is that it needs to be figured out before the property is under-contract and really tightened up prior to the expiration of the due diligence period.
Before we start on how to figure out the budget, let’s quick talk about the repairs that make money vs. the ones that cost money, but may be necessary. When renovating units, one of the traps to look out for are the non-money makers. Redoing the plumbing, heating, air conditioning, roofs, foundations, etc don’t add much value. If the residents don’t see it or use it on a daily basis, then it adds very little value. Those items may be necessary, but just understand that they don’t have a good ROI. With that said, if you are paying for the heating and AC bills for the apartment, then that may have a large effect on the NOI. If it is a needed item that doesn’t add value, you should be taking that right off of the purchase price.
Bathrooms, kitchens, paint and flooring are where the money is at. Focus on those items and you can really make a unit look amazing. The other major item, especially in B class apartments is the amenity package. Renter’s expect luxury and you need to provide it. If you can increase the pool patio, add grills, ping pong tables, make a new work out facility or 2, add in a dog park, volleyball courts and other sport courts, add in a package handling center, etc and you will attract better renters as well as higher rent.
Before you start throwing offers in on buildings that need large renovations, you need to understand how much things cost. You can do this a few ways, first, talk with other investors and find out what they pay, second – talk with your property manager and last would be to talk with your contractors to get pricing. The easiest way for me to look at a project is how much each item will cost or how much per square foot. When I go through an apartment building and see that each unit needs kitchen cabinets and counter tops, a vanity, toilet, paint, new flooring, new door knobs, light fixtures and plumbing fixtures I write that down. Then I go through those items to get a price.
Let’s look at these items and put a number to them in a B class apartment building with a 900 sqft unit in the Midwest:
Kitchen Cabinets and counter tops: $2800
Bath Vanity: $500
Flooring (luxury vinyl planking): $2500
Door knobs: $250
Light Fixtures: $350
Plumbing fixtures: $500
Total for the unit = $8650. I would now add on at least 10% to that, so each unit would be $9,515, from there is would round up to $9,600.
***Please do not use my numbers, they are for demonstration purposes only. Consult with you licensed contractor and property manager for the numbers in your area***
If you are first beginning, start with smaller renovations. As you gain experience, you will be able to estimate quicker, with more accuracy. One of the biggest traps is the small stuff and the stuff behind the walls. Sometimes you just can’t guess all of the problems and end up getting caught needing to spend major dollars over your budget. It is important to have a large reserve account and high profit margins.
I once bought a house with a little mold in it. That did not alarm me because the house was vacant and locked up in the humid summer, plus the plumbing pipes had burst. The amount of mold was small, so I didn’t think twice. When I bought the house and we started digging, we found out that some of the mold was caused from cracks in the stucco. Little did we know the house was letting water in, causing the studs and sheathing to rot out. As we removed the stucco, areas of walls crumbled. I could grab the studs with my hands and they would literally fall apart. This little hiccup ended up costing an additional $14,000 that was unforeseen. The good news is that we had a $20,000 contingency budget, but now we needed to buckle down to be sure that we did not get swallowed by extras.
I have endless stories like this, most of the time it is when I end up trying to change the floor plan by moving walls. If you are not well versed in construction my advice is to partner with someone that is, hire a very trusted contractor and property manager or just simply start with very light renovations. Either way, get to know your numbers and be sure to add an extra contingency budget.
Once you know your construction expenses, you then need to factor in you closing expenses. I had someone ask me if during construction, they had to pay for the electric, gas, water, taxes, etc. The answer is a big ol’ YES. Factor in how long it will take and then add in several more months (if you expect 6 months, count on 9+ months, even if your contractor promises 6 months). Add up all you electric, gas, water, trash, dumpster fees, permit fees, taxes, insurance, lender draw amounts, interest expenses, etc. If it will be a rental, you also need to consider your loss of rents and how that effects your return on investment. Often we think that because we are renovating, we are creating value, but if you could have bought a cash flowing asset with little to no work, you may be a head of the game.
In closing, estimating repairs can be difficult even for the most seasoned investors. Try not to be tight on your budget, as it is easy to go over budget. Contractors may tell you they can get it done for $5,000/unit, but contractors make a lot of money on extras and they likely will be happy to charge them to you.
To your success!