To Rehab or Not to Rehab?

To Rehab or Not to Rehab?

To rehab or not to rehab, that is the question?  I don’t think this was what Shakespeare was thinking about when he wrote Hamlet but it is a question you need to ask yourself if you are a real estate investor analyzing a deal.

When it comes to purchasing a home that is in need of rehabilitation, the question arises of whether it is really worth the extra cost to fully rehab a house or just make a few simple fixes, or do nothing at all. To rehab or not to rehab will depend on many different factors that you will need to thoroughly consider before making the decision to further your investment or simply sell off the property as is.

Your rehab ROI is arguably the most important factor when it comes to your decision-making in this regard.

Understand the Value

In order to understand your investment, you need to know makes the property valuable so you will then be in a position to know whether you should go further in your rehab efforts or sit pat on what you have. After all, it is possible to put a great deal of money into rehabilitating a home and not actually raise the selling value.

You will need to know just how the value of the home is determined and what separates appeal and actual value as well. Just because an addition may add square footage, that does not mean you will pull the money back out of the home when you sell it. You will also need to know just what types of upgrades or changes will make a real difference in the value of the property and calculate the money needed to create such upgrades.

For example, adding a deck to the backyard is nice, but may not actually add any real value to the home itself while the addition of more interior living space such as converting the attic or adding flooring to an otherwise empty area to create more room could boost the value of the property itself.

This will mean looking at homes which have sold recently in the neighborhood combined with the attributes of the home itself. If the home next door sold for $250,000 and was the highest sold price house in the neighborhood and is virtually identical to your home with similar features, then the selling price for your home should be similar.  It makes no sense to add a fireplace to your house if the neighbor doesn’t have a fireplace, or finish the basement in your house if your neighbor’s basement wasn’t finished. You can over rehab a home and not get back any of the money with improvements you put in.

An easy way to raise value is by adding a room out of space that was previously wasted like a storage area. But subdividing a three bedroom into a six bedroom in a neighborhood of three bedroom homes probably will not add any real value, will be a big waste of money, and will probably reduce your value because all the rooms will be tiny and not very functional.

Crunch the Numbers

Light rehabs are commonly referred to as prehabbing.  Sometimes leaving the house AS-IS and fully rehabbing may not be very profitable at all but cleaning out the house, painting it, laying new carpet down, and staging the home may be.  Here are 3 examples to illustrate what I am talking about:

Example 1: 

You get an amazing deal and purchase a house $20,000 below market value.  You do absolutely nothing to the house and relist the home AS-IS.

Purchase Price: $100,000

Rehab Budget: $0

Resale Value:  $120,000

Example 2:

You get an amazing deal and purchase a house $20,000 below market value.  You clean out the house, paint it, lay new carpet down, and stage it.  You spend $15,000 in rehab and your resale is now $160,000

Purchase Price: $100,000

Rehab Budget: $15,000

Resale Value:  $160,000

Example 3:

You get an amazing deal and purchase a house $20,000 below market value. You clean out the house, paint it, lay new carpet down, put tile in the kitchen, install hardwood in the living room, put in new kitchen cabinets, put in new appliances, put in 2 new bathrooms, replace the windows, finish the basement, and stage it.  You spend $55,000 in rehab and your resale is now $175,000

Purchase Price $100,000

Rehab Budget:  $55,000

Resale value:  $175,000

In examples 1 & 3, your spread was only $20,000 which means you didn’t make anything!   Two closings, holding expenses, finance charges, and Realtor commissions ate up all your profit.  In example 2, you did a light rehab which gave you a $45,000 spread.  After paying for two closings, holding expenses, finance charges, and Realtor commissions you made over $20,000.  Sometimes less is more!

In conclusion

Overall, there are a lot of factors to consider whether to rehab or not to rehab a particular piece of property. Sometimes you will make the most when you do nothing, sometimes you will make the most when you do a light prehab, and sometimes you will make the most when you do a full blown rehab.  The bottom line is that you will need to take them all into account before making your purchase so that you can get the most out of your investment.