How to decide if a rehab project is right for you
Updated: Feb 29, 2020
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:
The purchase of the property before it was rehabbed.
The cost of construction to renovate it.
The profit earned by the flipper or investor.
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.
Option 3: Buy low, fix it yourself.
If you have time to spare and can afford to live somewhere else for three to six months after closing while you have your house renovated (or do it yourself if you’re particularly handy), and you’re willing to put up with the stress and risks of a construction project, a fixer upper could be for you.
When you buy a distressed, unoccupied, or uninhabitable property, you are usually able to buy it at well below market value because it is either not functional or needs significant work, both of which drive the price down significantly. Ever seen the $500 vehicle for sale on Craigslist whose description reads, “...it only needs this, this, and this done to it for it to run, but either I can’t afford it or don’t want to bother, so I’ll sell it to you for practically nothing just to get rid of my headache.” When you buy a fixer upper, you are buying someone else’s headache for pennies on the dollar. If you know how to handle that headache while minimizing your risk and staying in budget, you can put yourself in an excellent position to reap all the benefits and rewards of managing your own DIY Rehab.
With your own fixer upper project, YOU get to decide how to renovate it, what finishes and fixtures to use, how to compose the layout if you're making changes or adding bathrooms. YOU get to decide on your construction budget, and get to make decisions with long term usefulness, durability, and future repair cost in mind. Most importantly, YOU get to reap the rewards of increased equity because you managed the work, and often times the ARV (after repair value) will be significantly higher than purchase price plus construction cost, creating immediate equity in your home. While the property taxes may increase slightly after purchase (they always do after a title transfer), the increase will be significantly lower because you purchased the property below market value.
There are even specific mortgage loans which you can use to wrap the cost of renovations into your total mortgage payment. I’ll go into the specifics of each of these in a later post, but some options to research include the following:
Fannie Mae Homestyle Renovation Loan
What each of these mortgage options have in common is that they allow you to finance up to 100-110% of the ARV of the property once repairs are completed, meaning that you can complete significant renovations with your mortgage and still keep your total monthly payment at or below what it would have been on a market value purchase. With the proper planning, patience, and vision, you can create your dream home with your first home.
What to expect with a major renovation project
If you think you might be interested in taking on a fixer upper, it’s important to keep your expectations in line with the realities, and make sure that your partner, if you have one, is on board as well. There are few things more stressful than a construction project not going as planned (and believe me, this happens almost every time), so making sure everyone is on board with the challenge is critical from the beginning. Here are a few final tips to keep in mind:
1. Plan your exit.
If you’re currently renting, plan to close on the property 6-8 months prior to the end of your lease so that you have plenty of time to complete the project before you suddenly have to move out of your rental and into a single bedroom with no running water and no kitchen (I say this from experience). Moving is stressful to begin with, moving into a construction zone and sharing a single toilet with contractors is a whole ‘nother ballgame. If possible, negotiate a month to month lease with your landlord.
2. Make sure you have enough cash to cover the unexpected.
Don’t use up all your cash savings in the down payment, make sure you keep enough out to cover unexpected expenses or construction surprises, they WILL happen, and it’s best to go into the project prepared. If you’re using a construction loan, know that the 10% contingency that the bank requires is there for a reason, and expect to use it.
3. Don’t hire the lowest bidder.
You wouldn’t hire the cheapest tattoo artist, don’t hire the cheapest contractor. The low bid is usually low for a reason: either the contractor is inexperienced, doesn’t fully understand the project and will try to upcharge you later, or does fully understand the project and is trying to win your business now and still upcharge you later. Look for quality, an established portfolio of work, strong references from other clients, and strong and prompt communication skills. Many contractors are notoriously terrible at communication, and may not respond to you for days or even weeks. You do not want to place your largest investment in the hands of someone you can’t get in touch with when things go wrong or become urgent. If they’re not calling you back, move on. I’ll go into more detail about how to pick a contractor in a later post.
4. Create a project budget, and track all of your expenses from Day 1.
What gets measured, gets managed. This is especially true if you are acting as your own GC and hiring subcontractors yourself, but it goes for anyone undertaking a home renovation project. By the time you have hired your trades, pulled your permits, purchased your faucets, picked up the tile, Amazoned the light fixtures, picked up your paint, ordered your cabinets, the matching oak flooring, your drawer pulls, your kitchen faucet, your appliances, your Ikea closet system, your curtain rods, your toilet paper holders… You get the picture. Create a system from day one that allows you to track all materials, fixtures and labor you have purchased or hired, and record every single transaction so you have a running total. It is absolutely possible to get a great deal on a house and build tons of equity by managing a rehab yourself, but it is also entirely possible to blow all your equity by not sticking to your budget. Make a budget, and stick to your budget.
5. Stay calm.
There will inevitably be a moment when you feel like you’ve gotten in over your head and wonder what the heck have you done. Maybe the roof is leaking again, maybe the plumber you had to fire cut huge holes in your floor joists under a cast iron tub, maybe you have to fire your contractor because they just aren’t showing up for your job. Maybe the contractors you fired broke into your house and stole tools and materials. Maybe there’s a plumbing vent running through your living room and the contractor is asking how you want that soffit. Know that renovation of old and broken down houses is messy, full of surprises, and rarely goes exactly according to plan or budget. If you know and expect this going in, you’ll be far better prepared to weather the storms when they come and keep your end vision in mind.
Even with all of the risks and challenges associated with taking on your own rehab project, the rewards can be well worth it. You’ll be able to blend historic character, modern conveniences, and your own personal touch to the final design, and this alone will increase the value of your property later when you eventually sell it down the road just because it is special and unique. Where other professional rehabs are selling as a commodity, yours will be one of a kind.
Heather Medlin is the design architect and founding principal of Ginkgo Vernacular LLC, serving residential and commercial clients in the greater Philadelphia area. She specializes in regenerative design and construction techniques for both building retrofits and new construction and is licensed in Pennsylvania and Washington, DC.