Strategy #7 - Rehabbing, Which of Course Leads To...

Strategy #7 is, again, one of my favorites: Rehabbing.

Rehabbing is taking a structure and giving it a face lift and a tummy tuck ;)

Many people believe that a building should last "a 100 years.." Well, the reality is that any building regardless of its use, (as in residential, commercial, industrial, etc) is made up of systems. The most obvious one, which is the one we see is the shell, or outer building. But buildings also have plumbing systems, electrical systems, HVAC or ventilation systems, and depending upon the use or complexity other systems including elaborate roofing systems and telecommunications systems.

And each of these systems has a different life. While the brick on the front of an old warehouse may last 50-150 years without much TLC, the electrical system may be "shot" in 25-30 years, and the roof may need to be replaced even sooner. However, just because a roof needs complete replacement does not mean we need to tear down the entire building.

There are a number of reasons why a building may need a face lift. Technology changes. Just yesterday we were combing around in the basement of a 12-Unit apartment we are about to manage the rehab of, and there was this thing in the basement that (I kid you not) was the size of two phone booths put together, but about 3/4 of the height. At first I thought it was a coal furnace, but then our contractor informed us it was a "gas furnace". Today, the same unit would be about 1/5th the size and 1/10 the weight of this monstrous beast. Way to big (and expensive) to remove, I suggested we sell tickets to let people come in and guess what it is (was). In addition to technology, tastes change. I remember wholesaling a single-family house a number of years ago when I was first getting started. I put a contract on the property with a lawyer who was representing an estate sale. The house seriously only had one owner since it was built in 1958, and the owner had not changed a thing. In many ways it was something out of the "Jetsons", full of "appliances of the Future". Was very retro, but no one would want to live in a house today with the type of appliances and bathroom fixtures this house had. In addition, the exterior needed work and again, the technology had changed in terms of exterior treatment. While there was nothing physically wrong with the wood siding, most people would want to have either a brick front, or vinyl siding on their house, as this is what "new houses" today look like.

The key to rehabbing is to know the market.

I have said this in earlier posts and I am also accused by some of my students of "pounding it over your head" in my home study materials, that 80% of the value of any house is not what is going on inside the house - it is the neighborhood!

This is why I laugh when I see some of these new "reality" TV shows that demonstrate "how to make money flipping houses". And as we know from prior posts, we do not use the "f"-word. They mean "rehabbing", which is not what everyone else means when they say: "flipping". In any event, I laugh because one of the serious flaws with these shows is they never talk about what is going on with the neighborhood in which a property is located. They talk about "colors, and bathroom fixtures" and what the hosts "thinks will sell", but they never say things like: "this is a blue collar neighborhood and what people are able to pay for houses is between x and y dollars", or "you will have a difficult time selling any house in this neighborhood without exposed brick on one wall and a roof top deck to see the harbor". In other words, the common elements in 99.9% of the houses in the neighborhood that makes that neighborhood what it is.

We have all been in places where we catch ourselves saying things like, "If this house was in that neighborhood it would cost twice the price" - you are correct! So, let's establish up-front that "Value" and "Cost" ARE NOT the same thing, and therefore, that spending "X dollars" to improve a house does not guarantee you in any way that you will recover 2timesX, or 3timesX, or even 4timesX dollars back. And this is the great fallacy of these shows that lead you to believe that in every situation or in every neighborhood you get back what you put into a rehab: WRONG. You get back what the neighborhood says the house is worth, and if you over improve a house, you will probably still sell it, but you may find out (at the end, when you can do nothing about it) that you have subsidized your buyer. If 99.9% of the houses in a neighborhood sell for $200K to $225K, and the cost of your rehab and house acquisition were $265K, then do not expect a new buyer to come along and pay $285K. No more likely the maximum offer you will receive (depending on what is going on with interest rates and other available "similar" properties) is $225 to $230K. Therefore you over improved your property by about $40K, and you will have to "eat it".

So, what are the keys to being successful at rehabbing:

#1 - Know your neighborhood! Starting with knowing what IS the Neighborhood. In a place like Prince George's or Montgomery Counties in Maryland, all you might have to know is a zip code, or the "subdivision". But in a place like DC, or Baltimore City, the neighborhood can change from "block to block". If you want to be a "successful" rehabber, you need to get into your car, with your map, and a knowledgeable mentor or real estate agent and learn the neighborhoods. You absolutely must know where your target neighborhood ends, and someone else's neighborhood begins.

#2 - You must know what is happening within the neighborhood. Is it improving, or is it in decline? Is it mainly a neighborhood of owners or renters? You can make money with either, but you will spend money differently on a property you intend to sell versus one you intend to keep and rent. What are some of the "core" features of a house that anyone moving into that particular neighborhood is going to expect? Finished basements, roof top decks, nice back yards for kids, etc. and of course, what are comparable values within that neighborhood.

#3 - You must have a handle on costs! In this business (Particularly rehabbing) you make your money when you buy, you recognize this profit when you sell and you lose it when the contractor shows up! There are a number of ways to get your arms around cost estimating and cost containment (does you no good to be correct on your estimate, and then overspend because of either a bad contractor, or a constantly changing scope of work).

There are a number of reasons to think seriously about rehabbing as an option, and an equal number of reasons to stay away from it as an investor. We'll cover more in these tomorrow.

Sherman Ragland - Thank you for reading...