Written By: Jacquelyn Annete García Vadnais
For many investors, it is very difficult to get into the real estate market and obtain the goal of having an investment property. One of the main barriers to entry can be obtaining enough capital to either purchase a home outright or to have a sufficient credit score to be approved for a loan. For this reason, many investors consider purchasing a home that is a fixer-upper in order to save capital on the upfront cost. Even though fixer-upper properties can be substantially lower in price, it is important to weigh the pros and cons of completing a fixer-upper renovation project. In order to learn more about important factors to consider when contemplating investment in a fixer-upper property, please review the information below:
The Pros of Investing in a Fixer-Upper
Low Cost for Proof of Funds
How to Decide Whether Purchasing a Fixer-Upper Is Worthwhile
Bearing the aforementioned information in mind, prospective investors should factor in several elements when deciding whether the Fixer-Upper they are examining is financially worthwhile. Below are three different calculations or variables to consider:
The Capitalization Rate
When considering how to calculate the Capitalization Rate, a prospective purchaser would total the purchase price of a fixer-upper including the projected renovation costs and assess the projected monthly rent minus operating expenses for repairs. Once one has taken the projected rent and subtracted the projected expenses, it will be possible to calculate the net operating income. With the net operating income, the next step is to divide by the total cost of purchase and projected renovations. This calculation will yield a percentage for the Capitalization rate. At this stage, the prospective investor can determine whether the percentage return makes sense for their investment portfolio and whether they are seeing a certain rate of return over a specific period of time.
The 1% Rule
The 1% Rule is a simplified way to determine whether a Fixer-Upper that an investor is intending to rent is worthwhile. After a prospective investor calculates the purchase price including the projected renovation price, they next should determine if the property’s suggested rental rate per month will be 1% of that total price. Prospective investors should ask their real estate agent for comparable prices around the property that they are considering fixing up to see what the traditional rates have been over the past five years. If the rates per month are 1% of the total purchase and renovation price, then it is worth it to consider investing in the property.
Determine if the Price is Less Than 100 Times the Monthly Rent
Another calculation to consider is whether the purchase price including renovations is less than 100 times the projected monthly rent. For example, if an investor is considering purchasing a property to renovate, it is wise to determine if the projected purchase price and renovation price is less than 100 times the monthly rent. If so, then it is good to seriously consider investing in the property.
Scope of Repairs
Aside from traditional calculation metrics, prospective investors may want to look at the projected list of repairs and decide whether the fixer-upper is worth including in their portfolio, as major structural renovations can be costly and lead to other hidden expenses. For example, if the property has substantial foundation issues, this can be a large expense that exceeds $10,000. Foundation issues may also reveal even more costly repairs that could impact whether a fixer-upper is worthwhile to invest in. However, if the property is merely outdated in its kitchen or bathroom, then this kind of project leaves room for design creativity and potential profitability. Prospective investors should be considering these factors when deciding whether the scope of repairs is worth it, and then balance that with calculations that outline the potential return on investment of the property.
Final Remarks
Purchasing a fixer-upper can be a very attractive option to prospective investors because they are likely to not have to show a large amount of capital in order to satisfy the proof of funds requirement to purchase property. In addition, they are able to make payments on the renovation costs over time, which will help spread out the cost of the purchase. The end result could prove to be a fruitful investment where they have passive income or a great value on a home that they decide to reside in. The key to taking on a fixer-upper is to offset the property’s future value after the renovations to ensure that the renovations do not cost more than the future value while factoring in the initial purchase price. If the numbers are favorable, a fixer-upper can be a valuable acquisition if the prospective investor also budgets for unexpected additional repairs that were discovered during renovations. If a prospective investor fails to make realistic projections about renovation costs, it can lead to taking on a fixer-upper that costs more than its value or to causing a lapse in cash flow during the renovation project. When considering taking on a fixer-upper property, it is wise for prospective investors to consider both the pros and the cons carefully to see if the property is the ideal choice for their real estate portfolio. For the prospective investors that do so, it can be an excellent way to save cash, and spread out the costs by purchasing a fixer-upper and renovating the property over a period of time.
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Jacquelyn Annete Garcia Vadnais is an Investment Consultant and field expert blogger for Barracuda Consulting.
Jacquelyn has a JD/ MBA from Suffolk University, an LL.M in International Law from the University of Miami, and a B.A. from the George Washington University in International Affairs with a Concentration in International Politics. Jacquelyn speaks English, Spanish, French, and Portuguese and has lived in ten countries. Jacquelyn has done work for firms such as Boston Consulting Group and has worked with firms based in over ten countries in the fields of Real Estate, International Law, Expat Living, International Business, Forex Trading, and Travel. She has also volunteered her time and expertise at the Victims Rights Law Center based in Boston, MA.
Please leave your comments below. If you would like to subscribe to our newsletter, click here: https://tinyletter.com/barracuda-consulting. To purchase a full real estate report, or to access a complete suite of investment advisory services please contact us: https://www.barracuda-consulting.net/contact.
For many investors, it is very difficult to get into the real estate market and obtain the goal of having an investment property. One of the main barriers to entry can be obtaining enough capital to either purchase a home outright or to have a sufficient credit score to be approved for a loan. For this reason, many investors consider purchasing a home that is a fixer-upper in order to save capital on the upfront cost. Even though fixer-upper properties can be substantially lower in price, it is important to weigh the pros and cons of completing a fixer-upper renovation project. In order to learn more about important factors to consider when contemplating investment in a fixer-upper property, please review the information below:
The Pros of Investing in a Fixer-Upper
Low Cost for Proof of Funds
Proof of funds is one of the most challenging barriers to purchasing real estate that prospective investors face. By investing in a fixer-upper, it is possible that a prospective investor will have to put down less capital at the beginning, which can be a great help in terms of being able to successfully purchase the property. Under this strategy, the renovation costs would not have to be shown at the beginning of the project in most cases allowing a newer investor more time to raise those funds as they are undertaking the renovation process.
Lower Overall Sale Cost of Property
When a fixer-upper is placed on the market, it tends to have a discount on the sale price or it is possible to negotiate a larger discount due to the property’s condition and the likely required work that is involved. This is a great way to save capital on the property since fixer-upper properties on average are listed at 8% below market value.
Property Taxes Will Be Lower
Property taxes are calculated based on the value of the property at the time of purchase prior to the investment of renovations. This means that a prospective investor would be able to save a great deal on property taxes by purchasing a fixer-upper.
Creative Freedom
Buying a fixer-upper that needs extensive renovations allows a prospective investor to make creative design choices that reflect their own personal style. This is an advantage in terms of cutting costs and making stylistic choices that are more affordable while being aesthetically pleasing.
The Cons That Investors Should Consider Before Investing in a Fixer-Upper
The Property Needs Too Many Repairs
One of the essential calculations that prospective investors need to make is how much the property is worth versus the costs of renovations. There are properties that need too much work relative to the projected value of the home after renovating. Prospective investors should be careful to be realistic about their projected renovation costs and decide whether the renovations are worthwhile for the projected value of the property in the future.
Uncertainty About Unexpected Renovation Costs
It can be very difficult to project renovation costs. While contractors can anticipate a reliable budget for renovations, they cannot always determine what unexpected repairs may come up as renovations continue. Prospective investors need to factor in surprises to their renovation budgets in order to be sure that they have a sufficient amount of capital to cover those costs.
Lengthy Renovations
Regardless of whether a prospective investor plans to reside in the house or to have tenants, it is important to realize that renovations can be lengthy and that there will be a period where there is a gap in capital from either not having a place to live during the renovations or not having cash flow from a tenant renting the property. Each prospective investor has to budget several months beyond their projected renovation schedule to allow for unforeseen delays.
Costly Building Permits
If the fixer-upper requires major structural changes, a building permit is required. This is something that has the ability to make a large difference in the cost. At times, fixer-uppers have foundation issues, which can add a substantial amount to the renovation budget in addition to permits that are required by the city. Prospective investors need to factor in all of these potential additional costs in order to avoid being over budget and running out of capital on their renovation project.
Lower Overall Sale Cost of Property
When a fixer-upper is placed on the market, it tends to have a discount on the sale price or it is possible to negotiate a larger discount due to the property’s condition and the likely required work that is involved. This is a great way to save capital on the property since fixer-upper properties on average are listed at 8% below market value.
Property Taxes Will Be Lower
Property taxes are calculated based on the value of the property at the time of purchase prior to the investment of renovations. This means that a prospective investor would be able to save a great deal on property taxes by purchasing a fixer-upper.
Creative Freedom
Buying a fixer-upper that needs extensive renovations allows a prospective investor to make creative design choices that reflect their own personal style. This is an advantage in terms of cutting costs and making stylistic choices that are more affordable while being aesthetically pleasing.
The Cons That Investors Should Consider Before Investing in a Fixer-Upper
The Property Needs Too Many Repairs
One of the essential calculations that prospective investors need to make is how much the property is worth versus the costs of renovations. There are properties that need too much work relative to the projected value of the home after renovating. Prospective investors should be careful to be realistic about their projected renovation costs and decide whether the renovations are worthwhile for the projected value of the property in the future.
Uncertainty About Unexpected Renovation Costs
It can be very difficult to project renovation costs. While contractors can anticipate a reliable budget for renovations, they cannot always determine what unexpected repairs may come up as renovations continue. Prospective investors need to factor in surprises to their renovation budgets in order to be sure that they have a sufficient amount of capital to cover those costs.
Lengthy Renovations
Regardless of whether a prospective investor plans to reside in the house or to have tenants, it is important to realize that renovations can be lengthy and that there will be a period where there is a gap in capital from either not having a place to live during the renovations or not having cash flow from a tenant renting the property. Each prospective investor has to budget several months beyond their projected renovation schedule to allow for unforeseen delays.
Costly Building Permits
If the fixer-upper requires major structural changes, a building permit is required. This is something that has the ability to make a large difference in the cost. At times, fixer-uppers have foundation issues, which can add a substantial amount to the renovation budget in addition to permits that are required by the city. Prospective investors need to factor in all of these potential additional costs in order to avoid being over budget and running out of capital on their renovation project.
Bearing the aforementioned information in mind, prospective investors should factor in several elements when deciding whether the Fixer-Upper they are examining is financially worthwhile. Below are three different calculations or variables to consider:
The Capitalization Rate
When considering how to calculate the Capitalization Rate, a prospective purchaser would total the purchase price of a fixer-upper including the projected renovation costs and assess the projected monthly rent minus operating expenses for repairs. Once one has taken the projected rent and subtracted the projected expenses, it will be possible to calculate the net operating income. With the net operating income, the next step is to divide by the total cost of purchase and projected renovations. This calculation will yield a percentage for the Capitalization rate. At this stage, the prospective investor can determine whether the percentage return makes sense for their investment portfolio and whether they are seeing a certain rate of return over a specific period of time.
The 1% Rule
The 1% Rule is a simplified way to determine whether a Fixer-Upper that an investor is intending to rent is worthwhile. After a prospective investor calculates the purchase price including the projected renovation price, they next should determine if the property’s suggested rental rate per month will be 1% of that total price. Prospective investors should ask their real estate agent for comparable prices around the property that they are considering fixing up to see what the traditional rates have been over the past five years. If the rates per month are 1% of the total purchase and renovation price, then it is worth it to consider investing in the property.
Determine if the Price is Less Than 100 Times the Monthly Rent
Another calculation to consider is whether the purchase price including renovations is less than 100 times the projected monthly rent. For example, if an investor is considering purchasing a property to renovate, it is wise to determine if the projected purchase price and renovation price is less than 100 times the monthly rent. If so, then it is good to seriously consider investing in the property.
Scope of Repairs
Aside from traditional calculation metrics, prospective investors may want to look at the projected list of repairs and decide whether the fixer-upper is worth including in their portfolio, as major structural renovations can be costly and lead to other hidden expenses. For example, if the property has substantial foundation issues, this can be a large expense that exceeds $10,000. Foundation issues may also reveal even more costly repairs that could impact whether a fixer-upper is worthwhile to invest in. However, if the property is merely outdated in its kitchen or bathroom, then this kind of project leaves room for design creativity and potential profitability. Prospective investors should be considering these factors when deciding whether the scope of repairs is worth it, and then balance that with calculations that outline the potential return on investment of the property.
Final Remarks
Purchasing a fixer-upper can be a very attractive option to prospective investors because they are likely to not have to show a large amount of capital in order to satisfy the proof of funds requirement to purchase property. In addition, they are able to make payments on the renovation costs over time, which will help spread out the cost of the purchase. The end result could prove to be a fruitful investment where they have passive income or a great value on a home that they decide to reside in. The key to taking on a fixer-upper is to offset the property’s future value after the renovations to ensure that the renovations do not cost more than the future value while factoring in the initial purchase price. If the numbers are favorable, a fixer-upper can be a valuable acquisition if the prospective investor also budgets for unexpected additional repairs that were discovered during renovations. If a prospective investor fails to make realistic projections about renovation costs, it can lead to taking on a fixer-upper that costs more than its value or to causing a lapse in cash flow during the renovation project. When considering taking on a fixer-upper property, it is wise for prospective investors to consider both the pros and the cons carefully to see if the property is the ideal choice for their real estate portfolio. For the prospective investors that do so, it can be an excellent way to save cash, and spread out the costs by purchasing a fixer-upper and renovating the property over a period of time.
--
Jacquelyn Annete Garcia Vadnais is an Investment Consultant and field expert blogger for Barracuda Consulting.
Jacquelyn has a JD/ MBA from Suffolk University, an LL.M in International Law from the University of Miami, and a B.A. from the George Washington University in International Affairs with a Concentration in International Politics. Jacquelyn speaks English, Spanish, French, and Portuguese and has lived in ten countries. Jacquelyn has done work for firms such as Boston Consulting Group and has worked with firms based in over ten countries in the fields of Real Estate, International Law, Expat Living, International Business, Forex Trading, and Travel. She has also volunteered her time and expertise at the Victims Rights Law Center based in Boston, MA.
Please leave your comments below. If you would like to subscribe to our newsletter, click here: https://tinyletter.com/barracuda-consulting. To purchase a full real estate report, or to access a complete suite of investment advisory services please contact us: https://www.barracuda-consulting.net/contact.
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