If you're thinking about investing in real estate, or if you're an investor with some experience, you're probably aware that any investment property you purchase will come with a list of items that need to be fixed.
A successful real estate investor has to be able to estimate rehab costs -- that includes both time and money that is being spent on rehabbing.
The following guide is meant as a general how-to for real estate investors; like the book on estimating rehab costs. Remember that every property will present its own set of unique challenges, but if you follow these steps you'll be able to adapt to problems as they come up.
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In simple terms, rehab costs refer to the expenses incurred in repairing and renovating a property. These costs encompass everything from materials and specialized tools to the labor required to transform a property into its optimal condition.
In the real estate industry, you may come across different terms such as rehab cost, repair cost, and renovation cost, but they all refer to the same idea of calculating the expenses involved in property rehabilitation.
Real estate is ultimately a numbers game, and property investors can only make a profit if the costs of a property are lower than the potential returns. Estimating rehab costs allows investors to evaluate whether a property's potential value exceeds the expenses involved in its rehabilitation.
By having a clear understanding of rehab costs, house flippers and investors can make informed decisions about property purchases, negotiate deals effectively, and ensure they are not overpaying for a property. Estimating rehab costs is a crucial step in the investment process that enables investors to calculate the potential profitability of a property and maximize their returns.
Whether you're a beginner in the world of real estate or a seasoned investor looking to sharpen your skills, this step-by-step guide will provide you with valuable insights and strategies to help you confidently estimate rehab costs and navigate the exciting realm of real estate investing:
Get ready to dive in and gain the knowledge you need to make informed decisions and succeed in your rehab projects.
Read Also: Fixer Upper: The (Ultimate) Guide
The first step in getting started on determining your rehab costs is to determine what actually needs to be done to the property. Start by pulling comps in the area.
Use these to develop a list of repairs and upgrades that a potential property will need in order to make a profit or turn up positive cash flow.
If you determine that the property has the potential for profit, the next step is to get or perform a detailed property inspection. This walkthrough inspection should give you a detailed look at what has to be fixed in order to legally rent or resell the property in your area. It is also a critical part of the due diligence process for any home purchase and is usually required by a lender. Give high priority to the items that this inspection identifies as problematic.
The property inspection will not identify items that are considered cosmetic. For example, while a property inspection can tell you that a roof will need to be replaced in the next three years, it cannot tell you that it's an odd color that will repel potential buyers.
Similarly, a property inspection will not indicate that appliances need to be modernized or bathroom fixtures updated. The specific needs for these types of rehab projects will likely be based on the comps in the area.
A scope of work is a detailed list of all of the renovation projects and repair work that will be performed at a property. When making this list, be sure to include:
Specifically, while you're compiling your list, consider these questions that many real estate investors often overlook:
Your scope of work will vary a lot based on whether you intend to rent out the house or make it into a flipper.
Rental property needs to start generating cash as soon as possible. The property needs to be in good repair to meet local housing requirements, but higher-end upgrades tend to add little to the amount of rent a tenant is willing to pay.
For example, it rarely makes financial sense to invest in landscaping for a rental property.
A budget for a rental property should have a strong focus on repair costs; everything must be functional in order to move in a tenant. Minor cosmetic details can usually be ignored.
Houses that are going to be improved in a few weeks or months and resold, or "flippers", will need to have a rehab budget that focuses on cosmetic upgrades.
The purpose of these investments is to improve a property so that it can sell for a higher price than it was purchased for. That means the focus needs to be on upgrades that add to the perceived value of a property.
If you plan on hiring labor for the work on your list, start interviewing contractors. Good contractors can often be found through recommendations of family and friends, online resources, or even the recommendation of your real estate agent. Carefully consider customer reviews when selecting contractors for a bid.
Ideally, collect at least three quotes for every item on your list. When comparing these quotes, do not simply choose the lowest bidder. Availability of the contractor and time to complete the project can have a big effect on carrying costs if you're investing in a flipper.
Investors in rental property will want to consider the quality of work that is being performed as well.
Once you've selected contractors, add a 5 to 10 percent contingency for all work. This is meant to cover the costs of additional materials and labor that may be needed should a problem arise.
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Here's one of the bathrooms we recently rehabbed in San Diego, CA. We tore out the old bathtub and pink wall tiles, took the walls down to the studs, then installed a tile-surround shower.
Real Estate Skills Tip: A bathroom rehab job can add more value to a home or rental unit than it costs to repair. Bathroom and kitchen renovations can produce some of the best ROI.
This is a common question among real estate investors. The truth is, it can be very difficult to estimate costs in terms of square footage. Some properties will need extensive repairs that may include very pricey items such as foundation work or HVAC replacement. Other properties may only need new appliances and paint.
New flooring will typically run between $2 and $6 per square foot, depending on if the material chosen is laminate, carpet, tile, or hardwood.
Paint is usually around $20 per linear foot if professionals are being hired to paint.
A full cosmetic renovation (which includes replacing lighting plumbing fixtures, etc.) runs around $35 per square foot.
Of course, the labor and materials market in many areas is extremely volatile right now. That means these numbers can fluctuate wildly, and even change in the middle of a rehab project. For this reason, it is recommended that investors do their due diligence and actually go through the process of writing out a scope of work rather than relying on sought estimates when making bids on the property.
Total rehab jobs are rehab projects that involve actually changing or making extensive repairs to the structure of a home.
This can include replacing a roof, water heater, and/or HVAC system. It is also not uncommon for total rehabs to involve the demolition or removal of all appliances and cabinetry in a kitchen and complete remodels of bathrooms. A rough estimate for a total rehab is between $85 to $100 per square foot.
For comparison, new construction homes have a cost range of around $180 to $250 per square foot. These estimates are not very reliable, however. Just like cosmetic rehab projects, material and labor costs can vary wildly based on the economy, local market conditions, and even the season of the year.
There are several ways to get estimates of the repair costs of a rehab project. Each of these methods has advantages and disadvantages:
Estimating rehab costs based on the square footage of a home is one of the least accurate methods for determining costs, but it is also one of the quickest. This method tends to work best for real estate investors that invest in properties with similar levels of disrepair; they can use the cost of their previous rehabs to estimate the cost of their next one. This method is notoriously unreliable, however, and shouldn't be used for actual cost estimates when considering a purchase of a property.
Many experienced real estate investors make an estimate of needed repairs based on what they have paid in the past for similar jobs. While this method is more reliable than a square footage estimate, there are several problems.
The best way to get an accurate estimate of the repair costs associated with a rehab project is to get actual quotes from contractors. Contractors can provide quotes for the actual project and can take into account all of the project variables.
Just be sure to pay attention to the length of time that the quotes are good for. Many contractors are offering very short time periods on their material estimates.
Whether you're virtual wholesaling, flipping houses, or building a rental portfolio, getting a line-item bid from local contractors will give you the most accurate price range for your rehab projects.
When it comes to estimating rehab costs in real estate, it's essential to recognize that the actual expenses can vary based on several factors. Understanding these factors is crucial for investors and flippers who want to accurately assess the potential costs involved in rehabilitating a property.
By considering these factors, you can refine your estimated rehab costs and make more informed decisions in your real estate ventures:
There are several different types of software that can be used to estimate project costs. Many real estate investors rely on these programs, especially in markets where materials and labor costs can change frequently.
Using rehab cost estimating software is also good for investors who want to run multiple scenarios for potential property investment.
Looking at how different materials or timelines can affect a project's budget can go a long way toward determining the scope of work that will be required. We can recommend BlueHammer as a helpful cost-estimating software.
Real estate investment is one of the most rewarding career fields, but it does involve a lot of planning and research. Estimating rehab costs and coming up with a scope of work is often a long process that requires days of research.
Once developed, however, the real estate investor will have a workable guide to everything that is supposed to happen with their property in order to obtain the highest after repair value (ARV).
Realize that the estimation process is just that; a process. An investor will have to make multiple adjustments as prices changes, workers' schedules shift, and projects become more involved. Realize that every project will be unique, and be willing to be flexible.
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