Value-Add Rehabs
Happy New Year, everyone!
New year…new bathroom? New kitchen? New floor?
Realtor Friend has a friend who lives in a large one-bedroom unit in a beautiful courtyard building in the Lakeview neighborhood here in Chicago. The unit has a great floor plan with a nice-sized kitchen and a dining room separated from the living room by cool French doors. Plus, there's a solarium where my friend loves to nap in his hammock, surrounded by his many plants.
His current rent is only $1,550 per month. Wow, that’s a steal! In that neighborhood, the market rent for a one-bedroom apartment is closer to $1,800 per month, and given its size, it could command an even higher rent.
So, why isn’t his landlord charging more? I think I have some ideas. For one, the landlord might feel uncomfortable raising the rent for long-term tenants, as he’s probably developed relationships with some of them, just like with my friend. Another reason could be that the unit appears a bit dated. The kitchen has old cabinets and a sink, the bathroom screams “original,” and the creaky hardwood floors, though charming, could use some polish.
From our perspective, this is a fantastic opportunity for value-add rehabs if the goal is to increase the property’s valuation.
Let’s break down the math to explain the rationale:
Assume the landlord can charge $1,900 per month after rehabbing the unit. Compared with the current rent of $1,550, that’s an increase of $350 per month. Over 12 months, that’s $4,200. Assuming the operating expenses (OpEx) remain the same (note that rehabs are considered capital expenses or CapEx), the net operating income (NOI) would increase by $4,200. At a cap rate of 5%, the landlord has essentially increased the value of the unit by $84,000 (i.e., $4,200 / 0.05). That’s just with one unit. If the courtyard building has 30 units, ceteris paribus, the whole building’s value would increase by $2,520,000. That’s a huge sum of money.
(For an explanation of NOI and cap rate, see the blog entitled “Key Concepts in Multi-Unit Property Investments.” )
But wait, you might wonder about the costs of rehab per unit. It’s imperative to work with entities that are reliable and understand the concept of “investor-friendly rehab costs” along with timely deliveries.
Assume the landlord has a budget of $18,000 to upgrade the kitchen and bathroom, install new vinyl floors, and add a fresh coat of paint throughout the unit. With 30 units, the total cost would be $540,000. That’s a lot of money, but the rehab costs can be covered by the rent increase of $4,200 per year, and in 3-4 years, as the saying goes, the rehab will pay for itself.
Upgrading a property can work wonders for boosting its market value. Think about it – modern amenities, fresh aesthetics, and updated systems make your property shine brighter, catching the eyes of potential buyers or renters. It’s like giving your place a much-needed refresh!
Investing in your property’s rehab isn’t just about the bricks and mortar; it’s about creating a space where people genuinely love to live. When tenants are happy, they’re more likely to stick around, reducing turnover and vacancy rates. After all, a content tenant is worth their weight in gold.
And let's not forget, a well-maintained and updated property doesn’t just blend in; it stands out in the market. It gives your place a competitive edge over others that haven’t had the same love and attention. This not only attracts higher-quality tenants but can also lead to increased occupancy rates. Everyone loves a winner!
For other multi-unit property investors, what are your decision criteria for deciding when to rehab a unit, and to what extent? What budget would you set aside for upgrading the bathroom and kitchen in your rental unit? Let's share our insights and strategies for making the most out of our investments!
