Articles

Estimating Rehab Costs: Be mindful of these 6 things.

Estimating Rehab Costs: Be mindful of these 6 things.

What can cause your original rehab estimate to change?

To make great returns in real estate often requires purchasing distressed assets and rehabbing them. That is how I purchased all of my properties (see real estate page). To submit an offer on a property, you need to come up with a rehab estimate. This generally involves doing a thorough walk-through of the property. Coming up with a rehab budget based off one walk-through can get you close to a somewhat reasonable number, but there are still 6 main events that have not yet happened.

These events can seriously change your initial rehab budget, so be forewarned! Here are the 6 main reasons why your original rehab estimate may change.

1. Home Inspections

  • I only order home inspections once I have an offer accepted. They occur during the 7 day inspection window before the actual closing takes place. These take a few hours and cost about $500, so I only do them if I am serious about a property and have it under contract. The home inspections are generally very thorough and reveal a lot about the property that you likely may not have noticed during the initial walk-through. I will have a later post about the home inspection process in more detail.
    • If something crazy comes up in the home inspection, I can do 1 of 4 things:
      • Go back to the buyer and ask them to fix certain items and keep the sale price the same
      • Go back to the buyer and negotiate a lower sale price
      • Accept the discoveries, keep the sale price as is, and add any additional items to your original rehab estimate.
      • Determine that the deal no longer works at this sale price or that the discoveries make me not want the property anymore so I can use the discoveries as my exit out of the sale contract.
2. Termite Inspection
  • I order a termite inspection to go with the home inspection. The termite inspection will either reveal that there was no sign of any past or present termite activity, or that there is signs of past or present termite activity. If past or present termite activity is noted, they will tell you if there is any damage. If there is damage, it will either be very minor or it can be very large where entire structures need to be replaced.
    • If the inspection reveals no signs of past or present termite activity, or there is but no damage is noted, then you are in the clear. Under this, you would likely just want them to come back out and treat the property and keep them on a regular treatment schedule.
    • If something crazy comes up in the termite inspection where there is signs of past or present activity and damage that needs addressed, I can do 1 of 3 things
      • Go back to the buyer and ask them to fix the damaged items and keep the sale price the same
      • Go back to the buyer and negotiate a lower sale price
      • Accept the discoveries, keep the sale price as is, and add any additional items to your original rehab estimate.
      • Determine that the damage is too significant and that I no longer want the property. I then just use this reasoning as my exit from the same contract.
3. During Rehab Process
  • Once the rehab is underway, you may sometimes notice items that need addressed that you didn’t on the walkthrough. You may open up a wall and notice a leak, that the plumbing was done incorrectly or simply needs replaced, that what you initially thought would cost $1,000 to repair now will cost $2,000, that the item you thought you could repair now actually needs replaced, etc.
  • During this process it is important to keep your eyes on your money as it can disappear rather quickly. If you don’t, you could find that the repair that now costs $2,000 instead of $1,000 means you will either go over budget by $1,000 (where will you get this money?), or that you can now no longer do certain other items that were in your original rehab budget.
    • Another option is to tell your contractor to just do what they can for the original $1,000. Depending on the item, though, this could be ill-advised. What future problems may show their ugly head if you take the shortcut.
4. Hopes and Dreams
  • You may do everything to a tee based off your original rehab budget, but wish to do a few other items that you now want to do for various reasons. Maybe you now see if you spend an extra $1k-$2k that you can increase rent by another $75-$100 per month. Or by spending $5,000 some new comps have come out where your ARV now goes from $85,000 to $95,000. Etc.
5. Simply Over Budget
  • Your rehab budget just simply ends up costing more. What your original scope of work thought would take 300 labor hours ended up taking 400 labor hours. Or your original scope of work left off a few items that you either forgot to add or you figured would be assumed, like finishing work. Most of my initial projects all had issues with the stage of rehab where the contractors essentially button everything up. If you do not include that very specifically on your scope of work, you could end up paying for that later.
6. Tenant Placement
  • Wasn’t sure if I should list this as the 6th thing that could change your initial rehab number, but thought it was still worth mentioning as I have had this happen to me. The rehab is complete, your property manager secures a tenant, and then the tenant moves in. Once they move in, they realize the water heater doesn’t work. Maybe it did before the rehab and now it doesn’t. Or maybe it never did. Or after 4 weeks the furnace needs replaced. They use the faucets for a few weeks and realize the drains are significantly clogged. Maybe they were before the rehab or maybe they weren’t.
  • I had a property that a tenant moved into 4 weeks after the rehab was complete, only to find that the furnace now needed replaced along with the water heater. Property 3/4.

Take-away Points

Given that your original rehab estimate can change, what are we to do? How do we even purchase properties that we plan on rehabbing if the original cost could go out the window?

Well, this is where being overly conservative can help. Especially if you are just starting out. I recommend listing all rehab items as separate line items. Then, have 2-3 contractors bid those line items out. Write out what each GC said each line item would cost.

Suppose a line item ranges from costing $100, $200, and 300 from 3 different GC’s. Depending on the property or situation, I will tend to choose the GC that is more middle of the road. Say, in this example, the $200 cost. However, in my rehab estimate I will assume it will cost $300. On top of that, I will assume it will cost 5% more than that.

Now this may seem overly conservative, but it helps ensure I have a lot of safety margin on the rehab. If you are new to investing in real estate and doing rehab projects, be conservative!

If someone says it will cost $20,000 for the rehab, don’t just assume it will. Add layers of buffer into your rehab number so you analyze the deal with the higher rehab cost. If the deal still makes sense, then you will feel more confident knowing that if things get uncovered during the rehab that you already have a margin of safety.

While I am always conservative in my rehab budget, as I have gained experience over the years and worked with the same general contractors, I am able to be a little tighter on the budget. This is because I have a better understanding of the rehab process and how my general contractor works. You will also better understand what types of things may come up during the rehab and be able to add those items into the original budget since you have had more experience. Again, though, I still am conservative to this day when it comes to rehab budgeting.

There is a lot more to be said of rehab, but I hope the above list helps you in just starting to think through the process and the costs involved (as well as the potential surprises!).

Newsletter

Subscribing is the simplest way to get started and to keep growing your future money trees.