Renovation

Photo downloaded from Pexels

Renovation is the process of adapting a property to your target tenant pool. It is a difficult balance between what is necessary and what is an unneeded enhancement. Work with your property manager to determine which is which. Listen to your investment team. If you don't trust your investment team enough to listen to them, get another investment team.

Why Is Renovation Necessary?

Rental properties are commodities to prospective tenants; they have no emotional attachment to any property or location. Prospective tenants compare your property to all properties across the city. For your property to rent, at least one prospective tenant must perceive your property as the "best" property for them. How do you make your property a top contender for "best" to a specific tenant pool? How do tenants decide what the best property is for them? Based on my research, tenants follow a fairly consistent search process. See the image below.

When people start looking for a property to rent, they start by eliminating properties that do not match their needs based on three criteria.

  • Rent Range - Tenants will not consider properties priced much over their budget, usually about 1/3 of their gross monthly take-home pay. And since people generally want to live in the best place they can afford, they generally do not consider properties priced much below their budget.
  • Needs - three bedrooms, a two-car garage, a large lot, what every prospective tenant believes is necessary.
  • Location - The location requirement is primarily driven by access to jobs, schools, the airport, etc., with a significant priority given to safety.

Properties that conform to the property profile for your target to the pool will satisfy the configuration, rent range, needs and location requirements. Meeting all three requirements will typically get the prospective tenant to stop scanning, read the description, and look at all the photos. However, just because a property meets the rent range, needs, and location requirements does not mean it is a desirable property to your tenant pool.

Renovation is the process of preparing the property for the market and satisfying as many of the tenant pool's "wants" as is economically feasible. Wants vary by tenant pool. For example, for one tenant pool, bars on all first-floor windows are essential. For another tenant pool, it might be granite kitchen counters. The properties that get rented the fastest and for the highest amount are properties that satisfy the most "wants," assuming rent range, needs, and location are satisfied. If you do not satisfy a sufficient number of wants, your only option is to lower the price until it is attractive due to the below-market rent or, even worse, it may attract a tenant from the wrong tenant pool.

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 property manager.

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 other properties for rent. 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. They spent $15,000 to $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 for a target tenant pool? Talk to your property manager. The property manager can tell you what to renovate for a specific tenant pool.

Basics vs. Required vs. Enhancement

I subdivide renovation tasks into three categories.

Basic

  • All systems (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. Saving money on the renovation is a costly mistake.

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. Below are some of the considerations for targeting this tenant pool.

  • 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 in the property and where we spend the most money. This tenant pool expects solid counters in the kitchen with an under-mount sink and 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.
  • 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 tenant pool that occupy the C Class properties I've dealt with.

  • Bars on first-floor windows.
  • LVP or tile floors. This tenant pool tends to do a lot of damage so you need very durable floors.
  • 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:

  • Carpet - Deep pile or wool carpets are more expensive, do not wear as well, and are unlikely to increase the rental rate.
  • Kitchen faucet - We use a brushed nickel gooseneck faucet that costs about $100. Spending 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 short 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 $2000. What is the payback period?

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

If I can recover the cost with increased rent 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 advantage. For example, if a property targets families with small children, installing LVP in the high traffic areas will save me money in the long run due to rapid wear on the carpet.

Renovation Considerations

The following comments apply to the tenant pool we target in Las Vegas. You will need to work with your investment team to determine the right renovation items for the tenant pool you target. However, the following should give you some good ideas.

Remove Potential Maintenance Items

We remove water conditioners, our systems, alarm panels, spas, intercom systems, and any of the new digital devices like Ring doorbell, Nest thermostats, satellite dishes, etc. All of these will likely result in higher support costs but will not increase the rent. Therefore, we remove them all.

Expensive Appliances

Not infrequently, when we buy a property it may have a high-end washer and dryer. We will typically swap these out with nice but reasonably priced standard models. We do this because if one of the appliances breaks, the tenant will expect you to install another high-end machine. We can get good used washers and dryers for $300 (in 2021). Buying a high-end washer alone can cost you almost $1000. So, we replace such appliances.

Landscaping

Landscaping can be an overhead cost you don't need. First, we remove high maintenance plants and, if necessary, replace them with very hearty slow-growing plants. Also, we make the tenant responsible for the care of the yard as part of the lease.

Execution

All too often renovation execution is where things go seriously bad. It is usually a combination of things including:

Contractors and Handymen

During the last 15 years I've been working with investors, I was forced to change renovation companies due to poor quality work, not showing up, drinking and drug use, and many other factors. Many were licensed contractors, and others were handymen. My experience is that the larger contractors are not interested in doing small work. And for some of them, anything less than $100,000 is small work. Plus, the quality I have experienced with many licensed contractors is way below what is acceptable. We've worked more with handymen and specialized tradespeople (plumbers, electricians, etc.) in the last few years.

Over Watch

In my experience, renovations do not just magically happen. If a knowledgeable person is not going onto the property every other day, things start going bad. Things are installed incorrectly, the wrong products are used, and quite possibly, the workers don't show up. One of our team goes on-site at least every other day. If you just hope things will work out all right, I believe it's going to cost a lot more and take a lot longer than you are expecting. If you don't have someone to overwatch the work, who knows what they are doing, things could go very bad during renovation.

Final Acceptance

The right person to do final acceptance is the property manager. When the workers believe all the work is complete, the property manager goes on-site with the renovation task list and checks each item. On almost every property, they found multiple issues that needed correction. If the problems are found at this point, there is usually no charge to have them corrected. If they are discovered after renovation, you will pay someone else to do the work

Marketing Photos

I have never understood why someone will spend $200,000 or $300,000 to purchase a property and another $10,000 to $15,000 to renovate the property and then settle for a few bad photos. I frequently see pictures on the MLS where the property looks more like a shooting location for a slasher flick than a place where I want to live. Hire a professional real estate photographer. And, even if uncle Bob just got a new camera and offers to do the photos for free, you can not afford it.

Enhancement Creep

Many times I've had clients who wanted to keep making "improvements" to the property. We do our best to resist this because rarely does anything beneficial come from these last-minute changes. What usually happens is that prices go up significantly, renovation time drags out, and there is no increase in rent or decrease in time to rent. In some cases, these additional enhancements made the property harder to rent and increase the time to rent.

Unexpected Costs

On almost every renovation, there are unexpected costs. Due to our processes, rarely due unexpected costs exceed $500. Part of the reason is that we do not purchase properties with higher-risk repairs. Almost all of our renovations are cosmetic: flooring, window treatments, kitchen counters, etc. When you have ill-defined tasks like mold, wiring, water damage, you can run into huge cost overruns.

In Conclusion

You can buy a great property in a great location. But unless the interior and exterior match your tenant pool's expectations, it is not going to rent or it will not rent for full market value.