Essential Renovation Insights
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First, what is the purpose of a rental renovation? Renovation is the process of modifying a property to make it more appealing to a specific tenant segment. The purpose is to increase the rent, reduce the time to rent, and reduce maintenance costs.
Renovation is also where things can fall apart. Why? Two primary reasons.
- Sometimes, owners remodel a property looks to fit their own tastes. This usually increases the cost and can make the property less your target tenant segment. You're selling a product, so you should give the customer (the target tenant segment) what they want.
- Another typical problem is what I call “improvement creep.” An example of improvement creep we experienced concerned granite kitchen counters. We use a low-cost, highly durable granite. The owner did not like the color of the granite, so he spent over $1,000 more for “prettier” granite. This increased the cost and did not enhance the property.
A question I often receive is, “How do you know what to renovate?”
What to Renovate?
If you are working with a good property manager, they can provide a list of tenant segment-specific renovation items.
If you're not working with a property manager, there's an alternative approach. You can use any real estate website to examine the condition of properties similar to yours that have recently been rented. From this, you can determine the "market-ready" condition for properties like yours.
You rarely have enough money to do every renovation item you would like. So, prioritize the money you spend in the following order:
- Health and safety - Do all the items necessary to provide a safe living environment. Not correcting all health and safety issues could result in injuries and litigation.
- Functioning systems - The HVAC and all other systems must operate correctly.
Attract the right tenant segment:
- Curb appeal: The property must look good from the street. I’ve seen potential tenants sop in front of a house with a yard in poor condition, and they concluded the interior would be no better and kept driving. If you can’t get people into the interior, you will not rent the property.
- Presentable: The house must be clean and attractive to the tenant segment you want to occupy your property.
- Competition: Some renovations will be required due to market competition. For example, suppose all similar properties on the market have granite kitchen counters, and your property has laminate. In that case, you may need to install granite to rent the property at market rate.
- Cost-justifiable enhancements: Changes that increase rent or decrease maintenance cost and have a reasonable payback period.
Payback Period
The formula we use for estimating the payback period for an enhancement is below.
- Payback Months = (item cost) / (monthly savings or increased rent)
For example, suppose the property has laminate kitchen counters. With laminate, the rent will be $1,700/Mo. With granite, the rent will be $1,900/Mo. The cost to install granite counters is $2,500. What is the payback period?
- Payback Months = $2,500 / ($1,900/Mo - $1,700/Mo) = 12.5 Months
If I can recover the cost in less than three years, I will almost always do the enhancement. The shorter the payback period, the more inclined I am to spend the money.
Documentation, Documentation, Documentation
This is where it things can go seriously wrong down. You have in your head what you expect abd the vendor has a different understanding. For example, how would you specify painting the interior of a house?
The interior, ceilings, walls, doors, casings, and baseboards will be painted as follows:
- Walls: Sherwin Williams White Duck in eggshell sheen. The code is SW 7010.
- Ceilings: Behr Flat White ceiling paint.
- Doors, casings, and baseboards: Swiss Coffee, semi-gloss sheen.
The price includes labor and materials, as well as surface preparation and cleanup. All switch and plug cover plates will be removed and reinstalled after the paint is dry. All door knobs will be removed and reinstalled after the paint is dry. Doors will be removed, sanded, spray painted, and reinstalled. The hinges will not be painted.
An unopened one-gallon container of each of the three paint colors will be left in the garage, and the names and sheen will be marked on the top of each can.
Even when I document each task as I did above, I sometimes have the vendor walk through the property and describe each task they will perform, how they will do the tasks, how many people will be working each day, and approximately when the work and cleanup will be complete. I video this walk-through, and it becomes part of the documentation.
Occasionally, a vendor claimed they did not agree to do something and wanted to charge extra. I showed them the video, which ended the discussion.
Creating unambiguous documentation for every item is time-consuming but essential.
Overwatch
We do several renovations each month, so we have a dedicated person to overwatch what is happening and take a progress videos. Unless you have a trained person (working for you, not the renovation company) monitoring progress and quality, the renovation will cost more, take longer, and the quality will be less than desired. Also, if the vendor knows there will be frequent inspections, they do better quality work and are less likely to play schedule games.
Coordination of Vendors
The order in which work is performed is important. For example, you do not want the walls painted and then have the electrician cut into the walls to install wiring. Or, if you have the new appliances installed before the new floors are installed. If you are managing the work, you need to create a work plan.
Changes
Every time there is a significant change, it must be documented with a change order. The change order must include a description of the change, any additional cost (labor and materials), and how much more time will be required. If there is no signed change order, we do not pay for it.
Final Acceptance
The final acceptance standard must be in the documentation. This should include an evaluation of all items on the original work order plus all change orders. Until all items are complete and the job site is broom clean, there will be no final payment.
Payments
We generally pay 50% of the estimated cost upfront and the balance upon completion. Sometimes, if there are significant material costs, we will make a progress payment but hold back a significant percentage until final acceptance is complete.
Who Does the Work?
We have tried several GCs over the years, and their work was consistently overpriced and of poor quality. Additionally, they did not make any effort to adhere to the agreed-upon schedule.
For the last >350 properties, we’ve worked with a handyman service. Where needed, we have licensed people do the work (significant plumbing, electrical, roofing, etc.) We are a high ticket customer for the handyman, where we were just a noise level nuisance for GCs.
Remote Renovations
You need to work with an investment team. If the team is a major customer of the renovation company, The team provides a lot of work to the GC. The vendor knows that in order to keep the business of the team, they have to execute every job, big or small, on schedule and budget.
Summary
- What you like or don’t like is irrelevant; only what the target tenant segment wants is relevant.
- There are no verbal agreements; document everything. Consider videoing the renovation company walking the job.
- Your job is too small to matter to most GCs. Working with an investment team provides the leverage you need to get your renovation done.
