Renovation - Required vs. Enhancement

Apr 26

A frequent question we receive concerning renovation is, "Which renovation items are required and which items are optional (enhancements)?" An excellent question, but the answer is not simple.

First, what is the purpose of renovation? I believe the purpose of the renovation is to maximize rent, reduce time to rent, reduce maintenance costs and increase tenant stay while only doing what is cost-justified. Before I get into details, we need to cover a few related topics.

How Tenants Find a Place to Rent

Prospective tenants searching for a property to rent (I will call them tenants for simplicity in the remainder of this article) follow a fairly consistent process. If a property fails any step, they eliminate it from consideration.

Rent - Typically, tenants choose the best property they can afford. A reasonable guess is about 1/3 of their household gross monthly income. They will not spend any time considering properties renting for more than their budget and probably not much below their budget either.
Needs - For example, if people have three children, they are not likely to consider a property with one bedroom.
Location - The locations people select are largely dependent on the location of their job(s), modified by safety, schools, and amenities like shopping.

Properties that meet the rent, needs, and location requirements will likely end up on the tenant's shortlist for consideration. What differentiates properties and gets them rented quicker and for a higher rent is by satisfying your target tenant pool's "wants." Wants vary by tenant pool. For example, for one tenant pool, bars on the first-floor windows are a major "want." For another tenant pool, granite kitchen countertops, and stainless steel appliances may be a major "want." If you understand your tenant pool, you will know what renovation you need to do and what you do not need to do.

We have one more important concept to get through before we get to the heart of this article. That concept is "market-ready."

Market Ready

A property is market-ready when a significant segment of your target tenant pool is willing to rent the property at maximum market value. However, market-ready is dependent on competition and other factors. For example, suppose there are many properties available that your target tenant pool is willing and able to rent. In that case, you will need to satisfy more "wants" to rent the property quickly and at the maximum market value. If there is little competition, you may rent the property quickly and at full market value without satisfying many "wants". However, if you do not satisfy sufficient "wants," your tenant stay is likely to be shorter than it could have been if more "wants" were satisfied.

Also, what is market-ready for one tenant pool is not necessarily market-ready for a different tenant pool. For example, for one tenant pool, vinyl floors in the wet areas is market-ready. Installing tile floors will increase the rent or decrease the time to rent by very little. For another tenant pool, vinyl floors in the wet areas would make the property virtually unrentable. How do you find out what constitutes market-ready for your target tenant pool? Talk to your investment team.

Can you significantly increase the rent by satisfying more "wants"? To a limited degree, yes. However, what you can charge for rent is limited by your target tenant pool's rent range, location, and competition. For example, suppose tile floors are needed to attract your tenant pool. Installing travertine marble floors would probably decrease the time to rent but would have little impact on the rent because the tenant pool is unwilling to pay significantly more for the upgraded tile.

If you significantly enhanced the property, could you appeal to a higher-income tenant pool? Probably not due to the location of the property and similar factors. For example, a few years ago, I came across a property for rent in an area I know well, but the asking rent was about $300/Mo. more than I believe to be market rent for that location. Intrigued, I viewed the rental property and was amazed at how over-improved it was. They installed costly tile flooring, new (beautiful) kitchen cabinets, Bosch appliances, etc. I checked the price of the refrigerator, and it was over $4,000! The property sat on the market for months. Over time they slowly decreased the rent. Eventually, it rented for about $50 to $75 more than similar properties in market-ready condition. My guess is that they spent about $20,000 more on the renovation than necessary and only increased rent by a small amount.

How do you determine what items are required and what are enhancements? Talk to your property manager. A good property manager can tell you what to renovate for a specific tenant pool.

Basics vs. Required vs. Enhancement

I divide renovation tasks into three categories.

Basic

The systems work - (water heater, HVAC, appliances, faucets, drains, toilets, lights, etc.) must operate correctly.
Clean - The property has to look and smell clean. I am amazed at how often I go into properties for rent, and the property is dirty and or smells bad. A stinky or dirty property will not rent quickly or at full market value.
Attractive - Colors should be uniform and neutral. Remember that uniform and neutral are location-dependent. For example, white walls may be the right color in one location, while light tan may be the right color for another location.

Can you rent a property that is not clean or attractive by reducing the rent? Yes, you can. The problem will be time to rent, rental rate, and worst of all, tenant quality. Under most conditions, the only people who will rent a property that is not market-ready are unlikely to take care of the property. When they move out, the property will likely need significant renovation.

Required

What is required is tenant-pool specific, so I cannot provide specifics that apply to all tenant pools. However, I will compare requirements vs. enhancement for two different Las Vegas tenant pools.

The first tenant pool I will comment on is the one we target and typically only rents Class A and higher-end Class B properties.

Neutral colors - We use three paint colors: a light tan color for the walls, an off-white color for doors, trim, and cabinets, flat white for the ceilings. Multi-colored properties do not rent as quickly or as fast.
Materials - We use brushed nickel for all metal parts like faucets, doorknobs, towel bars, ceiling lights, etc. We primarily use LVP (Luxury Vinyl Plank) for all floors. If carpet, a speckled tan nylon carpet.
Kitchen - The kitchen is the most important room and where we spend the most money. This tenant pool expects solid counters in the kitchen with an under-mount sink with a gooseneck faucet.
Master bathroom - Brushed nickel faucets, and sometimes we upgrade the countertops to granite with under-mount sinks. We use either tile or LVP for the floors.
Appliances - If we have to replace all the kitchen appliances, we use stainless steel.
Window treatments - We use 2" white faux wood blinds for all windows. While they are not the most desirable to all tenants, they are universally acceptable.
Ceiling fans - Ceiling fans are relatively inexpensive and very desirable to our tenant pool. We almost always install them in the master bedroom and the living or family room.

In comparison, below is what is necessary for the C Class properties I've dealt with.

Security - Bars on first-floor windows.
Flooring - LVP or tile floors. Sometimes carpet in the bedrooms. Hard flooring is best because this tender pool is likely to damage carpet or anything else like that.
Counters - Laminate counters are fine, as long as they're not too damaged.
Appliances - We use low-cost used appliances for the kitchen, typically white. White tends to be the lowest-cost appliance color.
Window treatments - Low-cost curtains, multiple colors are acceptable.
Lighting - If we replace light bulbs, we use low-cost energy saver bulbs.

As you can see, the requirements for the two tenant pools are very different.

Enhancements

Enhancements can either be a waste of money or almost a necessity. It depends on competition and the payback period.

Waste of Money

Some examples:

Upgraded carpet - Deep pile or wool carpets are more expensive and are unlikely to increase the rental rate.
Upgraded kitchen faucet - We use a brushed nickel gooseneck faucet that costs about $100. Spending much more would be a waste of money for most tenant pools.
Bathroom counters and sinks - if we replace the bathroom sink and countertops, we use builder-grade granite with under-mount sinks. Designer sinks are more expensive, would not increase the rent, and are more prone to be damaged.
Custom color schemes - We do not do accent walls or any other type of custom colors. Every additional paint color increases your painting cost, and it will not increase the rent.

Worthwhile Enhancements

If enhancements can pay for themselves in a reasonable time period, I am very likely to do them. For example, suppose the property manager tells you granite kitchen counters will increase the rent by $100/Mo. and the cost is $2,000. What is the payback period?

$2,000 / $100/Mo = 20 months or just short of 2 years.

If I can recover the cost in less than 3 or 4 years, I will almost always do the enhancement. The shorter the payback period, the more inclined I am to spend the money. If it takes longer than 4 or 5 years, I will not do it unless there is another reason to do so. For example, if a property targets families with small children, installing LVP or tile in the high traffic areas will save money in the long run due to rapid wear on the carpet.

In Conclusion

Regardless of the tenant pool, you will have to do all the basics. Beyond the basics, it's dependent upon the tenant pool. A good property manager can tell you what is required and what is an enhancement. If enhancements have a short enough payback period, I will do the enhancement. If not, unless there is some other compelling reason, I will not spend the money.

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