How to decide if a rehab project is right for you

Updated: Mar 1, 2020

Fixer upper, home for sale, west philadelphia

To kick off 2020, I'll be doing a seven part series on buying and financing your first rehab project. Stay tuned to learn more.

If becoming a homeowner is on your list of goals for 2020, you’re probably already househunting on Redfin or Zillow and have at least six properties saved in your initial flurry of excitement over the prospect. But the process can be daunting, especially if it’s your first time, and making some key decisions up front can really help streamline the process and make sure you’re happy with your purchase down the road. If you haven’t already, check out my post Five Questions to Get You Started and make sure you’re clear on your budget, your neighborhood, and the size of house you’re looking for.

With those basics out of the way, one of the most significant questions you’ll need to answer is whether or not you’re willing to take on a fixer-upper, and how much work you’re willing to do. Rehabbing a house is not for everyone, but the advantages of building equity, full customization, and inherent quality upgrades can make it well worth the tradeoffs. But before we dive into the benefits of doing the rehab yourself, let’s look at the alternatives.

Option 1: Buy an already rehabbed property.

Commonly known as a “flip” or a “rehab,” you’ll quickly become familiar with this specific species as soon as you start looking at homes with your realtor (advice on picking a realtor coming soon!). These are fully renovated, like-new homes that are move-in ready, typically located in marginal, “up and coming” neighborhoods where flippers and investors can buy a fixer-upper, typically at below market value, do the renovation themselves, and then “flip” the value to the high end of the market and sell it back to you at a profit. They typically all look very similar and can be fairly formulaic in layout, materials, and fixtures, and you’ll quickly notice that you’ve seen the same grey vanity with the white top in multiple houses before long. These homes are being renovated by real estate investors, and they are trying to maximize “the look” while minimizing their cost in order to sell it to you at maximal profit. (I have nothing against real estate investing, but it’s all in how you do it…)

Because of the very nature of this transaction, two things are happening here.

One, this type of real estate deal is a key contributor to gentrification, because it takes a house with low tax value in a neighborhood of low tax value and significantly increases its tax value, often 2-4x, in a matter of months. Higher income individuals and families move in to lower income neighborhoods, property tax values increase, and lower income families and long time residents find themselves paying increasingly higher taxes as the neighborhood continues to gentrify, and may find themselves forced out of the neighborhood altogether if they can’t afford the higher bill. (Caveat: this is not the ONLY contributing factor to gentrification, nor are mixed income neighborhoods necessarily a bad thing, and I would also not assert that every aspect of gentrification is negative. But the mechanisms at play here will continue to put upward tax pressure on existing and lower income residents unless cities put policy in place to mitigate this.)

The second thing that’s happening is that YOU are footing the bill on four things in this transaction. Included in your purchase price, which you will pay interest on for the life of your mortgage, you are paying for the following:

  1. The purchase of the property before it was rehabbed.

  2. The cost of construction to renovate it.

  3. The profit earned by the flipper or investor.

  4. The government’s cut in capital gains tax on the profit earned by the flipper, which you better believe they have factored into their calculations.

What you get in return, however, is a fully renovated home, ready to move-in, with zero time investment, headache, or construction stress. Time is money, and if there’s one thing we like to pay for, it’s convenience. You can usually find out exactly what has been done during the rehab in the property disclosure, which should typically include a roof replacement, new plumbing, new electrical wiring, and a new HVAC installation at the very least, and may also include a new hot water heater and other appliances. The vast majority of construction cost goes into necessary systems upgrades and envelope repairs, so look past the fancy finishes to make sure that the quality you’re buying reflects that.

It is very important to check that these major systems have been replaced in the renovation, because otherwise you are paying top dollar for lipstick on a pig: fresh drywall and finishes covering up an old house that will soon reveal itself in one maintenance issue after another. If you are buying in Philadelphia, you can also check the status of any building permits or past code violations on Phila Atlas, just type in the address of the property. You’ll want to make sure that the renovations actually were done under a permit, this ensures that construction was done to code and inspected for compliance before drywall was installed. In Philadelphia, construction requires separate permits for demolition, plumbing, electrical, and HVAC installations, in addition to a general building permit.

Option 2: Buy a previously owned, previously rehabbed property.

This is a good middle ground, because in this scenario you will be buying a previously rehabbed property (in which all the aforementioned checks should be evaluated before you buy) which someone else has purchased, lived in for a while, and possibly made some or all of the upgrades on their own. The house probably won’t look brand new, as life has a way of putting wear and tear on anything, but it will likely have the systems already upgraded, be fully functional and move-in ready, and require only a limited amount of cosmetic work to customize or refresh it.

The price point will also likely be at or close to market value, as it will have experienced natural appreciation and adjusted to local values in the neighborhood. By being owner-occupied, it will also probably have been reasonably well maintained, and you can expect to move right in to a fully functional, livable house. If you have a vision for customization, you’ll be able to jump right into those upgrade projects rather than spending the first six to twelve months making your home habitable, and you’ll be able to put your dollars and sweat equity to work at your own pace while living there.