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If you are a regular reader of my blog, you know that in my opinion buying a fixer upper home, rehabbing it, and either selling or managing it is an excellent investment property strategy. I like the strategy because as long as you have access to capital, you can acquire these properties on the cheap and use your own sweat equity to dramatically increase the values. However, you must be cognizant of hidden costs.
One of the most underestimated hidden costs is holding costs or carrying costs. These represent the property expenses you will need to cover while executing the rehab project. These include loan payments, utility expenses, property taxes, landlord insurance costs, etc. Obviously you will not be collecting any property income during the rehab project, so all of these carrying costs will come directly out of your pocket.
Therefore your goal is always to complete the project as soon as possible, because doing so minimizes the amount of carrying costs you will have to fork out. But unfortunately, more times than not, you will run into delays. Previously-unanticipated repairs, delays renting out the finished units, or delays closing on the refinance are all common reasons why rehab projects can take longer than expected. So you will want to add a buffer to your holding cost estimate, in the 20-30% range. This will ensure that you can cover the holding costs even if the project gets delayed, thereby allowing you to stay within your budget.
Another hidden cost relates to concealed property damage. Whether you get a property inspector or not, you can never be 100% sure what lies behind the walls. Things like black mold, rotted studs or joists, and similar things are not readily apparent at the time of acquisition but can be expensive to deal with once found. So again, add a 20% buffer to inflate your repair cost estimate, just to be safe.
In the final analysis, rehabbing fixer upper homes is a fantastic real estate investment strategy, but you must make sure your expenses do not get out of control. Always inflate your cost estimates by 20-30% to compensate for project delays and hidden costs. This will ensure that your initial project analysis is on target and that you will remain within budget.