Presented with opportunity and concealed with risk, real estate investments are among the most favorable ways to grow one’s financial wealth. This lucrative endeavor also comes with its share of uncertainty and unforeseen costs, which have commonly hindered investors in the past. In part one of our two-part series, we evaluated the costs associated with beginner and intermediate investments such as wholesale and prehab deals.
In part two, we’ll run the numbers on more real estate investments, including rehab and rental property deals.
The Costs Of A Real Estate Rehab Deal
The grand slam of real estate investment is the almighty rehab. Although more risks are involved compared to a wholesale and prehab deal, the payoff is tremendously bigger. Completing an after-repair value estimate will provide you with the best picture of what you can sell the property for, and it’s recommended you use local comparable listings and sales as your guide.
A focal point for many rehabbers is the kitchen. Not only is it the most popular room in a house, but it also yields the highest return on investment. When weighing your decision about whether to rehab the kitchen, it’s important to ask yourself the following questions:
- Painting: It’s recommended to use neutral colors when painting, including one for baseboards, trim and ceiling, and one for walls. General painting costs could range upwards of $1,500.
- Framing And Drywall: How can you open up the space? Do you need to remove any walls? Does any of the drywall need to be replaced? General costs could range upwards of $2,000.
- Flooring: Your choice of flooring should be dependent on the area. A general rule of thumb for flooring is to use hardwood for living spaces and kitchen areas, carpet for bedrooms, and tile for the bathroom. General costs could range upwards of $6,500
- Kitchen: Should it be upgraded? If not, a full gut is needed. What is your budget? General costs could range upwards of $10,500.
Other aspects to consider when rehabbing include plumbing HVAC and electrical. Similar to the kitchen, bathrooms are one of the best selling points of a property and should be given a strong focus. A review of the home’s electrical and HVAC system is also recommended, as homes with proper heating and cooling capabilities tend to sell faster, and for much more. You can expect to spend approximately $3,000 to $5,000 on electrical repairs or updates.
- Bathrooms: Should it be upgraded? If not, a full gut is needed. What is your budget? General costs could range upwards of $7,000.
- Plumbing, HVAC, Electrical: How many “wet locations” (ie: bathrooms, kitchen) are there? Does your HVAC need to be replaced or serviced? Is there any noticeable damage to the electrical work? Does the panel need to be upgraded? General costs could range upwards of $10,000.
A general overview of the costs associated with a rehab will look similar to the following:
- Low Cost: Landscape, small repairs, and painting (estimate: $25k-$45k)
- Medium Cost: Kitchen renovation, bathroom upgrade (estimate: $46k-$75k)
- High Cost: Foundation issues, roof leak, sewer lines (estimate $76k+)
It’s also important not to forget any miscellaneous costs associated with wholesale, prehab or rehab deals. Additional costs to account for include:
- Marketing Costs: Every real estate investment will come with marketing costs, but the good news is this money will only ensure your property gets sold faster.
- Holding Costs: These expenses are inevitable, especially for rehabbers, as they directly relate to keeping the property running while you complete the necessary work. This may also include additional costs such as loan repayment fees, insurance, utilities, and property tax.
Return On Investment: Generally speaking, a rehabbed property will fetch a much higher ROI compared to a wholesale or prehab deal, thanks largely to the upgrades and risk involved. However, calculating the return on investment in real estate can be both simple and complex, depending on all the variables mentioned above.
As a real estate investor, it’s important you’ve done your due diligence on a particular property, including an exit strategy, in order to minimize possible risks and costs, and get the most bang for your buck. Having the right numbers in place will ensure your real estate deal survives the turbulence of your investment journey.
The Costs Of A Real Estate Rental Deal
Another channel in the investment pipeline is rental properties. These lucrative assets are perfect for long-term appreciation and positive monthly cash flow and have become extremely popular in recent years, especially with mortgage rates so low.
There are two ways to obtain a rental property: you can either purchase it outright as an investment, or you can buy it as an owner occupant.
- Rental Property: Most investment loan programs consider a rental property riskier than an owner-occupied property, so it will require anywhere between 20 to 30 percent to secure traditional financing, including a 0.75 higher interest rate.
- Owner Occupant Property: Unlike the rental option, the owner-occupant route allows investors to purchase a rental property with the best financing terms–as little as 3.5 percent with FHA financing. However, owners must live in the property for a required twelve months, as part of the owner-occupied loan requirements.
Each option involves different mortgage financing, including additional costs, so it’s important to understand the in’s and out’s of each option. The monetary aspects to consider are:
- Property Taxes: This tax is based on the jurisdiction in which the property is located. While this tax is typically included in the mortgage, it will range in price depending on where your rental property is located.
- Homeowners Insurance: This cost varies depending on the property’s location, but could be significant affected if the rental property is located in areas prone to natural disasters.
- HOA Fees: These are monthly or annual fees associated with your rental property for the maintenance of common areas in the community. ($100-$500 per month)
- Maintenance: The recommended budget for maintenance is typically 10 to 15 percent of the annual property rent.
- Utilities: The tenant is typically responsible for the majority of utilities, but some services like water and sewer are the property owner’s responsibility. ($30-$200 per month).
- Property Management: If you plan on using a rental property management company, their service costs typically range from eight to 10 percent of the monthly rent.
Return On Investment: The financial benefits of a rental property are second-to-none. Although calculating the ROI (return on investment) for an investment property is somewhat complicated, renting will generate a steady monthly paycheck, which essentially covers your mortgage, as well as any price appreciation during the renting time span.
Fortunately for investors, many of the costs associated with rental properties are also tax-deductible. Consider interest, depreciation, repairs, local and long travel, home offices, insurances, and legal and professional services.
Author Bio: Than Merrill, founder of FortuneBuilders, is considered to be one of the nation’s most successful real estate investing moguls. As a Yale graduate, former NFL player, and star of A&E’s “Flip This House”, Merrill attributes his success to coaching and education. Currently residing in San Diego, CA with his wife and son, Merrill continues to pursue his passion for inspiring his students and all those around him. Follow him on Twitter @ThanMerrill.
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I had the benefit of a real estate agent as my rental real estate mentor.
For each place we saw, I’d say, “How much to fix it up like I’d want it?”
He’d go through the list out loud, similar to what you have above. I’d add that to the cost of the place, look at rent possibilities, and make a decision to make an offer or not.
Can’t imagine having done that without him.
Rehabbing a fix and flip can be a lot of work. A lot of people think its a walk in the park on all investments. Borrowers really do their due diligence and have to look at the costs of repair before they jump into a investment property.