It’s been a long dry spell, but it’s looking like significant improvements are providing a better return on investment for real estate investors than they have in years. That’s good news for flippers, because that’s just one more way for a fix-and-flipper to add value.
The latest Cost vs. Value Report, done every year by Remodeling magazine, is indicating that the resale value added that is attributable to specific renovation projects has improved across the board since last year, for every renovation category the survey tracks.
So it appears that for the focused and cost-conscious fix-and-flipper, the numbers are close enough that remodeling is now at least a potential profit center, given the right set of circumstances.
Nationwide, the top remodeling project, in terms of the recovery of money invested, is a new steel entryway door. On average, property owners who made that repair believe they got 96.6 percent of their money back on resale. Essentially, that was a break-even proposition.
Not far behind were the addition of a wood deck (87.4 percent) and the addition of an attic bedroom (84.3 percent).
Now an ordinary investor might look at these and say, “Well, it doesn’t pay to remodel. Even at their best, these are break-even projects.”
That’s not how a flippin’ insider would look at it.
A flippin’ insider would take a look at this data, boil it down to the local level as much as possible (Northeasterners care more about central heat than Hawaiians!), and use that to bid down the purchase price of properties that call for these specific renovations.
One of the nice things about the Cost vs. Value Report is it provides a handy ballpark estimate of the usual costs of certain kinds of repairs. You can print out the report – both nationwide and for your region – and use it in the field as a quick reference for how much money each renovation may be expected to cost.
Let’s look at a simple example: Fourth on the list is the garage door replacement. According to the editors of Remodeling, replacing a garage door costs about $1,534, but it only seems to add about $1,283 to the resale value of the house, nationwide. So in the aggregate, property investors lose about 16 percent on the investment. That’s not good … unless you’ve already taken the cost into account when you buy the property.
Look, some of these remodelings aren’t entirely optional. If a property needs a garage door replaced, it needs a garage door replaced. If you don’t do it, someone’s going to bid your resale price down anyway. If you’re the one who takes the initiative to bid down the price of the new garage door, then you are the one who stands to profit from the economic activity – even if the remodel shows up as a money-loser in the Cost vs. Value Report.
Here’s how that might go down:
You identify a house that last sold five years ago for $200,000. Other similar houses in the neighborhood have been selling for about $240,000 lately. But this one desperately needs a new garage door.
You know you want to make at least 30 percent on your money on a flip. It’s not as easy as it used to be to do that, but it’s still doable if you know your market and you hustle enough to be able to afford to be picky. You think the guy’s a motivated seller, anyway, so you should be able to get your margin. So you back off the market value, with a new garage door, by $72,000. So that takes you to $168,000.
Naturally, if you know you’re going to have to throw some money at a reno, you want to get 30 percent return out of that money, too. So you take the $1,500 estimated cost of repairing a garage door and add 30 percent to that, which takes you to $1,950. Call it $2,000 – math is an exact science, but not real estate investing.
You can work out the numbers with the seller. He might not have the liquidity to throw $2,000 at a garage door in order to sell the house, so don’t be shy. Your value proposition is getting him $166,000 for the house quickly, no muss, no fuss, so he can get on with his life.
You’re entitled to your 30 percent on your money – or whatever you think a decent margin should be – accounting for your risk and time, and the time your money will be tied up in the house, if you can make that happen.
So in that situation, is the garage door a money-losing renovation? Certainly not! It’s an opportunity for you to profit, under the right circumstances.
Is it a deal-killer? At $1,500 on a $240,000 house you can buy for $168,000? Heck no! Go ahead and make the deal happen. You don’t have to grab every last penny on the table! It’s better not to, if you can get a few referrals out of it.
Now, what happens when the numbers run a little bigger? In this case, things get a lot dicier, because it’s tougher for you to build in what Warren Buffett has called the most important concept in investing: a “margin of safety.” I probably wouldn’t touch the $49,438 average cost to add a bedroom attic on a similarly priced home, unless it was already almost done. That is, unless I could be pretty certain that the actual cost, given the current structure, would be nowhere near the $49,438 that Remodeling reports it costs.
Otherwise, to get 30 percent on my investment, I’d have to bid a $240,000 home all the way down to $103,000. Here’s the math:
$240,000 x 0.7 to get an offer at a 30 percent discount for my margin, MINUS $50,000 x 1.3, to get a number that will account for the average investment in adding an attic bedroom, plus a 30 percent return on that capital investment as well.
Is the guy likely to take $103,000 on a $240,000 house? Probably not. Do I have any reason to believe the new buyer is really going to value the attic bedroom at another $65,000, or anywhere close to it? Not at that price point. Maybe I could get it on a million dollar house, but in that case, there’s a lot more room to play in the margin.
A 30 percent target margin on a million dollar house is $300,000. I could easily put an attic bedroom in without having to upcharge, walk away with $250,000, and be quite content. If I can knock one big project down all at once, with only ONE set of negotiations, ONE set of attorney’s fees, ONE day spent at the closing table, and lots more time to prospect, market, work on other projects or enjoy time with my family, I can afford to give up a few points of profit margin, and still come out just fine.
Now, it may well be that adding that attic bedroom is a mistake. Statistically, that seems to be the case on average. I would look to the norms in the neighborhood and the likely buyer to guide me. Am I making the home that much more desirable to people with families? Is this a family neighborhood? That attic bedroom isn’t much value to a retiree moving to a golf resort, but it could be a big bonus to a family with a 12-year-old child who would love that room.
Do most of the other similar homes have three bedrooms and this one only has two? Am I simply bringing the home into conformity with other homes available in the same area? There’s no hard-and-fast answer. I would make my best judgment call. But I would try to create that margin of safety, where I can afford to make a mistake or two.
See, I can insist on less of a margin, and be more liberal with renovation projects, on high price-point homes. On one condition:
I must always, without exception, do my buying at a discount to market value. I must always make my money when I buy. Not when I sell.
That is the way of the flippin’ insider.
Renovations and the Importance of a Margin of Safety
http://www.engage360.me
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