This year I have met many clients who are exploring whether to buy a property to rehab or not. Other of my clients are thinking of a rehab on a home they have purchased in the last few years that no longer serves their needs.
In some cases there is a fear of doing a renovation that I detect. As a Loan Officer who has a specialization in 203k and HomeStyle rehab loans I can detect the fear most times. The fear is in one of two areas – The Cost or The Process. In this post I want to address the Cost fear because I see those buyers walking away from rehab projects that would be a good practical and usually a good financial decision for them. Fear of numbers should never drive a decision not to do a rehab that can yield benefits.
Fear of Cost
Fear of costs involves sudden exposure to large rehab budget numbers that clients just are not familiar seeing. For example let’s say a client finds an old home from the 19th century that has been poorly cared for over the years and hacked up across time by owners who were thinking they were “modernizing” the property. That meant removal of valuable vintage items like built-in dining room hutches & cabinets, architectural columns, wall sconces, art or stained glass, etc. This still upsets me when I see it. Today these original features may be too costly to replicate but would add value if they were still there.
In this example an old house is selling for $200,000. It is so far gone that almost nothing can be salvaged. It needs new wiring, HVAC, roof, windows, floors, plumbing, sewer lines, mold remediation, and siding. Plus a new kitchen and a new bath or two.
Now let’s say the buyer is purchasing at a discount for the neighborhood because this is the worst house on the block. In my work as a Renovation Loan Officer I always say, “Buy the Worst House in the Best Location”. Why ? Because of the potential increase in value at completion of the rehabbed home relative to the other nicer houses that will be used as comparables to set the value of the one to be rehabbed. This “as finished” value is projected up front with a 203k or HomeStyle renovation mortgage prior to purchase. Should the future value projection fall short the buyers can cancel the purchase.
Here is where the clients can feel their fear of costs. It is really a fear of the unknown. In this example to do all the work above a General Contractor may present a proposal for $150,000. To a client who has never priced all this rehab work before that can seem to be an outrageous number and a scary one. After all most clients do not have the funds in cash. That’s why they need a 203K or HomeStyle loan.
In this example the client may have fear of two numbers – the purchase price and the rehab cost. The total is $350,000. But if the cost of this money is typically about $5 per each thousand dollars borrowed in monthly payment, is that really so scary ? Since both 203K and HomeStyle loans are amortized over 30 years and with an interest rate that can never change it can make sense to finance a rehab this way. This is true for a new purchase or a home already owned needing funds for rehab.
But the key is what will the value of the house be at completion. Here if the completed remodeled home will be worth say $375,000 or more then isn’t that good news ? The “as finished” appraisal report will validate whether this is a good decision or not. The appraisal report will show what this old $200,000 house will be worth with the above $150,000 renovation. This is determined up front, prior to even closing on the sale of the house. Should the appraised “as finished” value be much less than the expected $375,000 then the buyer can cancel the deal. Or the buyer can go back to the seller for a price reduction perhaps.
I see this fear of cost with smaller numbers and larger ones. Clients who have never priced out the true cost of a rehab with a General Contractor are often shocked at the numbers and all the tasks. I have met clients who think their friend who is a handyman on the side can do it for pennies on the dollar. That’s just not reality with local building Permits required to be purchased to use 203K or HomeStyle. In most cases Architects Plans must be drawn as a requirement to secure Permits at some cost. Both 203K and HomeStyle require a licensed Contractor(s) which bars any sort of unlicensed handyman types from being involved. But if the numbers work to the owner’s advantage then fear can be removed.
I once had a client buy a little house that was a trashed foreclosure for $43,000. She then put $21,000 into it for a new kitchen, bath, floors, lighting and paint. The future “as finished” value was projected by an Appraiser at $84,000. She was very happy and is living in a fully updated house for less each month than she had been paying for rent.
I recently visited a house my clients were bidding on to see for myself what sort of rehab was needed. It was nearly 100 years old but a solid brick home with some recent HVAC updates and a second bath added upstairs along with another bedroom in what had been an attic. In this case the clients wanted to completely rebuild the first floor to create a modern open floor plan and reconstruct the expanded attic to make more second floor square footage. When the purchase price was added to the estimated cost of the rebuild it became clear the “as finished” value would not support the rehab cost, some $250,000, given the expected purchase price. But knowing this up front has allowed the clients to look for a more suitable home that can better meet their needs with a more modest rehab budget.
I counsel clients not to be afraid of cost numbers because the reward comes with the knowledge of the “as finished” value of the property seen early on prior to committing to the process.
I always tell clients to “Buy the Worst House in the Best Location”. That’s usually the best way to go about purchasing a home to renovate and removing the fear of cost.
I hope this post has been helpful and encouraging to those that may have thought a Renovation project was too complex or beyond their ability to manage. My intent is always to inform, educate, and generate discussion. Please call me or email me directly or visit my website for more information on renovation loans. I welcome your comments and questions!