In this real estate market there is no good reason to buy a property that you plan to hold and rent if it needs any more than about $2500 worth of work.
It’s just not necessary, because there are so many great properties on the market – and I mean listed on the MLS and STILL occupied – that will cash flow as a rental at or near full asking price.
I took a quick look last night at one of the cities that I track and in about five minutes I identified six properties that met that criteria.
But yet every week I hear about and get emails from investors that are seriously negotiating on properties with mold, with foundation problems, and even one with termites (Yes, there are homes with termites here in the Midwest. Not many but they do exist.)
And I shake my head and ask “why?”.
Because the last three properties that I purchased needed, all together, a grand total of $3500 worth of work. And that amount included one electrical upgrade from fuses to breakers ($500) and one black-pipe gas line ($750). The rest was paint and minor stuff like smoke detectors and basement stairway hand rails.
But the two things that really don’t make sense about taking on these huge projects are the repair costs and holding costs.
Think about it. You buy a home for $20,000 and you put $20,000 more into it to turn it into the nicest $850 per month 3 bedroom rental house in town.
How are you going to get your money out? The new lending rules say that you can’t refinance based on appraised value until 12 months after purchase, so your $20,000 in repair cost gets to sit locked up in the property for an entire year when it could be off earning greater returns elsewhere. Heaven forbid that you used a line of credit for the rehab – you’d have negative cash flow from day 1.
But you’d still have the honor of having the nicest $850 per month 3 bedroom rental house in town!
The second problem is holding costs. You obviously can’t rent the property while you’re working on it, and even a small renovation project can take upwards of 60-90 days, so at a minimum you need to pay taxes, insurance, utilities, and maintenance/yard care for two to three months, and you may even have principal and/or interest if you financed the purchase.
The striking thing is that if you do the math you’re realize that holding costs for three months of rehab can amount to the rental profit on a property for up to three years.
So in other words, by doing a big rehab on a property that you want to rent and hold, you’ll need to rent it out for up to three years just to break even on the holding costs.
Why would you want to handcuff yourself like that?
Contrast that with the no rehab houses that can be bought off of the MLS. As I have written here in the past – I collected a deposit for the most recent one that I bought before I even closed on it, and the weekend following the closing I traded the keys for the first month’s rent. So there was virtually no gap between buying it and putting it into profitable service.
Which would you rather be? Profitable in month 1, or profitable in month 37?
I’m a recovering finance guy, so for me it’s obvious! 😉