Renovation projects on income producing properties are a bit tricky. Smaller operators tend to either over- or under- finish, and this leads to challenges getting that target return on investment (ROI).
Below are the steps we use to figure out the best game plan on a specific properties, with examples from our own portfolio.
- Research. Research. Research.
Each property is in a different market, unless they are literally right next to each other. Even then differences are possible. Knowing that local market and how it is being impacted by growth patterns, local development plans and business investments is the most important thing in developing your renovation plan. Ask yourself:
- What are my exit strategies? If you’re buying to hold or have a multifamily building then the finishes are different than someone planning to sell a SFH in a few years to an owner-occupier and are using the rents to ride out the market volatility. Know who you are and will be compared to at exit.
- What does my competition currently look like? Do they have granite, washer/dryer connections, dishwashers, microwaves, and modern finishes? Or are they leasing up with threadbare carpets, poorly patched drywall, doors that don’t properly latch, and minimal used appliances? Knowing this will allow you to position your property for minimum updating while attracting the best of the tenant base looking in that market. You can find this out by checking websites and photos of properties for sale, but even better is to do some mystery shopping. Drive around (or hire someone to) and gather photos and data on your own. Marketing does not always match real life.
2. Decide on the target market
A renovation is not done on a whim. For some reason, this unit isn’t performing to the business plan and needs some kind of change. Assuming from the research in step (1) you found some differences between this property and the competition, now we need to decide what the goal of the renovation is. Ask yourself:
- What is the target tenant profile? Do you want to position the property with lower than average rent to fill vacancies quickly and keep occupancy high or higher than average rent to attract higher income earners? Do you expect high turnover in the market or is the tenant base sticky? While it is great if you can attract multiple types, picking one tenant profile that best fits the business case helps to guide the property design.
- What rent level matches your target tenant profile relative to the competition? Is the larger market generally growing so pushing rents could work or is it stagnant/shrinking so that staying at or below average would get the unit filled faster?
3. Decide on a target finish level
Based on the information from (1) and (2), you can match the chosen rent and tenant profile with what other local properties are offering. That gives you a starting point for developing your own target finish level. After you have this starting point, ask yourself:
- Do I need to do all of these changes? If not what are the changes that will yield most of the return with the lease investment? If you’ve heard of the 80/20 rule, it applies here as well. Sometimes a simple face lift is enough to get to the target rent levels.
- How long do I plan to hold the property for? If you’re doing a quick 1-5yr hold, putting in very robust finishes to minimize ongoing maintenance may not provide a strong ROI. That’s not to say buy the cheapest possible finishes (most of those fail in a year or two). For example, you may need to chose between installing tile floors in kitchens/baths (almost never replaced) vs high end wood-look sheet vinyl (5-10 yr replacement) vs laminate vinyl plank (LVP) (20-25 yr replacement). These choices are unlikely to impact rent significantly, but they do impact maintenance and operation reserves so it is important to weigh the choice against the business plan.
- How long can the property be vacant for? This is an often overlooked cost of renovations. Every day someone isn’t paying rent that counts as a loss of income. If you are tight on money and reserves, you need to consider this loss of income in your business plan. If you can’t find quality people to do the bigger lift work quickly and in your budget, doing a smaller but faster face lift may work best. Changing out cabinet and door knobs, bath hardware and a fresh coat of paint can work wonders and can be done in a few days.
- What finishes are readily available? With the supply chain issues, sometimes the finish we want is not there. Or consider that picking a specialized light fixture that then gets broken can delay a later turnover. Picking from finishes that are readily available in your market and likely to continue to be helps source materials quickly even after the project is done.
4. Review the plan and get feedback
Steps 1-3 guide you to a solid plan for your property renovation. If you’re relatively new to the market, now is a good time to ask for feedback on the plan before you execute it. A property manager (or a few) are best if you have developed those relationships already. If not brokers are another good source because they see sales and comps all day and generally want to get on your good side for when you go to sell (or buy a new property) at some point. Use this time to cross-check your research data as well.
Deciding to do an interior renovation can have a very positive impact on a properties return on investment, often called “forced appreciation” because they can lead to higher income which increase the overall property value.
To avoid spending more than needed or spending to little and not getting the right impact, ensure you have a solid plan by following the steps above.
Have questions? Want to talk about renovations more?
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