In the last post, we covered how investors evaluate where to invest and your options for the type of property and tenant before selecting properties. In this post, I will review how to define investment criteria and due diligence around the next criteria:
4) PROPERTY CONDITION
Unless you are considering investing in new construction (which has its own challenges), the property likely has some defects which can range from small maintenance items that the previous owner delayed addressing to major damages that may need immediate attention to pass local building code inspections. Smart investors know that repairs offer the opportunity to create value.
Here are the main questions to answer for yourself to evaluate which projects to pursue:
1) How flexible is your repair budget? Your budget may look different if your strategy is to Buy & Hold, Buy & Flip or even Buy, Rehab & Refinance. Your budget must cover what your contracting team can easily identify as well as a buffer for more complex or harder to estimate repairs. Ultimately, you have to validate your repair budget against the estimated ARV (After Repair Value) and expected market rents to win on your investment.
2) What repairs can your current team handle? Quite frankly, many of the defect conditions I observe in homes were caused by DIY owners or low-skilled handymen. Do you have a general contractor that can manage the required specialists to rebuild a shell into a livable property? Or, do you just have a handyman that can handle mainly cosmetic repairs? The reality is that the best deals require the most rehab work. However, these jackpot deals could be out of your reach if you do not have a capable crew to complete the project on time and budget.
3) How does the condition of your target property compare with the other buildings on the same block? Real estate professionals rate both neighborhoods and buildings into a class from A to D that factors in the age of the properties and the included amenities. To maximize your return, a smart investor will match their rehab budget to the features available within the other existing housing stock on the block (i.e., put Class A amenities into a building in a Class A neighborhood). If you are an early investor on a block, you may have to rehab multiple units to justify putting in Class A amenities on a Class C block or risk a negative return on your investment.
In summary, these questions can help you:
- Be clear about your feasible repair budget. A mistake with your repair budget can lead to additional holding costs and reduced profit on your deal.
- Decide what kind of repairs to pursue. Your current team will largely dictate your decision. If you think you are ready to take on larger projects, you will need to add more experienced contractors to your team.
- Move through your due diligence faster. The goal is to put your negotiating chips on the table early and confidently head to the settlement table.
In the last part of this series, I will cover financial metrics.