Investing in real estate is a fantastic way to supplement your income or to build long-term wealth. Like with every other business though, you’ve got to keep your eyes on the profit. When estimating rehab costs you need to account for three major components: the price you’ve paid, the costs you’ve incurred during the renovation process and the sales price that your property fetches on the market. Our previous blog installment highlighted common pitfalls in evaluating the after-repair value of the property. Today’s article is focusing on major mistakes in evaluating the costs of owning and rehabbing your investment property.
NOT BUDGETING FOR THE CARRYING COSTS OF YOUR PROPERTY
The costs you are about to incur consists of two major components. The first one is obvious – it is the amount you are planning to spend renovating your property. There are other types of costs, however. One of the most common mistakes we see investors make when estimating rehab costs is forgetting to budget for them. I am specifically talking about carrying costs. Carrying costs and costs associated with owning a home.
Carrying costs include property taxes, homeowner’s / condo association dues, insurance, payments on your loan, utilities and basic property maintenance such as landscaping upkeep. Remember the joke that there are only two things in life that are certain: death and taxes? If you are in rehab business, there is a third: carrying costs. These costs can sneak in on you and slowly but surely nibble your profits away, especially if you are making these mistakes:
NOT HAVING RESERVES
There is no way to avoid carrying costs, so you might as well be prepared to cover them. This is why it’s important not to spend your last dime on paying for renovations. When estimating your rehab costs, you must have enough money set aside to pay for the carrying costs expenses as they occur.
Not working with the sense of urgency is one of the main mistakes a rehabber can make. Each rehab has many components and each of those components might depend on several vendors and decision makers. To say that managing them is like herding cats is an understatement. You’ve got to keep pushing to avoid your time being sucked into a black hole. Any delay literally costs you money and cuts into your profit.
ESTIMATING YOUR REHAB COSTS BASED ON THE BEST CASE SCENARIO
Almost all of our borrowers have ambitious goals of finishing their rehabs in record time. “It will take me three to four weeks!” they tell us. It’s great to have this sense of urgency – you need to push yourself to finish your project as fast as you can. However, few rehabbers can meet such an aggressive goal. It always takes a couple of months more than you’ve planned.
The same with estimating rehab costs. It feels that almost always it costs more that you’ve expected. It’s OK. It’s the nature of the business. Where you run into trouble is when your rehab only makes sense under the ideal circumstances. I’ve seen new investors cutting their previous rehab estimates down ten to fifteen thousand dollars to make their expected profits higher. Of course, at this point that profit is “on paper only” and has very little to do with what you would incur.
Unexpected costs will happen. To avoid working for nothing, plan for them. Do your best to avoid them, but make sure your deal has enough margin to be profitable if it takes you two extra months to finish or if you must fix something that you haven’t planned to fix before.
New Funding Resources is a private mortgage lender doing business exclusively in Maryland, Washington, DC and Virginia. In business for over 11 years we work closely with the DC area rehabbers to help them make money and manage their risk.