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Many commercial and residential real estate investors are experts at finding distressed and vacated properties they can quickly renovate and list for sale (aka “flip” or “flipping houses”).
In my role as a real estate agent, I’ve seen quite a few homes in need of some “TLC”, which in real estate terms, means “Tender Loving Care”.
From my experience, a house for sale’s listing that has those three letters in the description usually means some minor and easily manageable repairs may be required, such as a fresh coat of exterior paint, re-pointing porch stairs, installing a new water heater, or re-sanding the wooden floors.
And other times, TLC may stand for “Totally Lost and Confused”.
That’s because what started as a dream can quickly turn into a nightmare if you do not carefully analyze the costs of key components of the property and the associated repair and replacement costs as well as taxes, fees, materials, and labor.
Here are 5 tips to help you figure out if it’s worth it to buy that fixer-upper home or if you should keep looking:
1. Know What You Can Do Yourself
Before I got into working in real estate, I would use an agent to assist me in my real estate transactions.
I also pay an accountant to do my taxes, a barber to cut my hair, and a professional contractor to build my homes.
I’ll freely admit that when it comes to anything beyond minor fixes and maintenance, I am not skilled at difficult home remodeling projects. I simply don’t fool myself into thinking that I can take on more than I can chew with repairs that I have no previous experience or knowledge in fixing.
I advise my clients to adopt a similar mindset when they are considering purchasing a fixer upper.
Thanks to wildly popular home repair shows like “Flipping Boston” and “Flip This House” TV remodeling shows make home improvement work look like a snap.
In the real world, attempting a difficult remodeling job that you don’t know how to do will take longer than you think and can lead to less-than-professional results that won’t increase the value of your fixer-upper house.
Do you really have the skills to do it? Some tasks, like stripping wallpaper and painting, are relatively easy. Others, like electrical work, can be dangerous when done by amateurs.
When deciding whether or not to buy a fixer-upper home, you have to ask yourself these 3 important questions (and be 100% honest):
- Do you honestly have the time, desire, energy, knowledge, experience, and mindset to fix up the house and do it well?
- Can you take the required time off other work, responsibilities, and family life to renovate your fixer-upper house?
- If you live in the fixer-upper, how stressed will you be when you’re living in a work zone for several months while work is being completed on the fixer-upper?
If your honest answer to each of these questions is “Yes”, then proceed with the purchase of the fixer-upper house.
If not, then keep looking.
Inevitably, another fixer-upper will pop on the market soon and you will have a new opportunity to create your dream.
2. Get the Total Cost of All Repairs (including permits) BEFORE Making an Offer
Your best bet is to use a qualified and knowledgeable inspector to do a walkthrough of the fixer-upper house to identify what needs to be done with the place.
The inspector should also provide a written cost estimate on the important tasks to do.
If you’re doing the work yourself, get the estimate for supplies and remember to add an additional 10-20% to the cost to cover any unforeseen problems that may come up with the fixer-upper project.
Do you need a permit to work on a fixer-upper house?
I’ve seen situations in fixer-upper houses where work was done without a permit.
Going this route may save money, but in the long-run it’ll lead to problems when you try to sell the house.
You need to decide in advance if you have the time to acquire the required permits yourself or have the contractor do it.
As we all know, the process of getting permits can be an extremely time-consuming and frustrating experience for a lot of people.
Plus, inspectors may require you as the new owner to do additional work or dramatically alter your original plans before a permit is pulled.
3. Verify Pricing for Required Structural Work
I’ve been in more tha a few fixer-uppers in need of major structural work in order to be legally occupied.
Hiring a structural engineer before you put in an offer will cost you on average between $500 to $700 to detect any structural issues with the fixer-upper home.
This is an important step to ensure you stay within budget and you have the right funds needed to remedy any stuctural problems found by the engineer.
Remember to always get any estimates for structural repairs in writing before you commit to the purchase of the fixer-upper.
When deciding whether or not to buy a fixer-upper house that requires major structural repairs, I advise my clients to NOT buy it unless these factors are taken into consideration:
- You have in-hand a binding written estimate for the repair and replacement work.
- The house is deeply discounted and priced to move immediately.
- Any savings in the cost can then be re-invested into fixing the structural issues (provided you know the up-front costs).
- The full extent of the structural problem is known and can be fixed immediately.
4. Know Your Financing Costs
Another significant cost that you must consider when deciding to purchase a fixer-upper house is the downpayment, closing costs, and of course the repairs.
Can you recoop these costs when you purchase and do the required work needed to get this fixer-upper house up to snuff?
Using a Home Equity or Home Improvement Loan for a Fixer-Upper House
Many people opt to to take out a home equity or home improvement loan to fund the repairs needed for a fixer-upper.
Here are the important things to consider with this type of financing:
- Get pre-approved for your home equity and/or home improvement loans before making an offer
- Structure the deal to be contingent on receiving both the home purchase loan and the renovation loan. Doing this enables you to not be forced to close the sale without a loan to actually fix the house!
- Look into the Federal Housing Administration’s Section 203(k) loan, which is designed to help homeowners to buy or refinance a fixer-upper home. This useful financial instrument combines both the purchase and rehab costs into one single mortgage.
To qualify for the FHA Section 203(k) loan, the total property value of the home must fall within the FHA mortgage limits for the area, similar to other FHA loans.
The 203(k) program provides an additional amount of money for renovation (up to $35,000) on top of the mortgage. Speak with your loan originator for more details on this type of loan.
5. Calculate Your Offer with Inspection Contingencies
When calculating your offer to purchase a fixer-upper house, I advise clients to take the “fair market value of the property” (i.e. what it would be worth if the home were in good condition and updated) and subtract from this number the total aforementioned upgrades, permits, and repair costs.
Here’s an example of how to present an offer to buy a fixer-upper house with contingencies.
Let’s say your fixer-upper house you want to purchase features an outdated kitchen from the 1970’s, peeling wallpaper, filthy wall-to-wall carpeting, and extremely high radon levels in the basement.
Your real estate agent pulls a comp for a recent sale of a house in the neighborhood that sold for $300,000 that features a newly updated kitchen, freshly painted walls, hardwood flooring, and a new radon mitigation system in the basement.
Your costs to re-do the kitch, scrape wallpaper and paint, tear out the carpeting, resanding the floors, and installing a radon mitigation system in the basement is $50,000.
Subtracting these costs for the repairs ($50,000) from the comparable price ($300,000) gives you a bid offer of $250,000.
When presenting the offer, it may also be a good idea to share these cost estimates with the sellers, to prove your offer is fair.
How to Include Inspection Contingencies In Your Offer
From my experience helping people buy fixer-upper properties, I’ve found that most home inspection contingencies allow the buyer to go back to the seller and ask them to do the repair, reduce the price, or simply give cash at closing to pay for the needed fixes.
Keep in mind that if the inspection uncovers a major issue, the seller can back out, as can you as the buyer. If this happens, then consider the fact that this particular fixer-upper is not for you.
However, another fixer-upper will inevitably come on the market, and when that happens, you will know what to do when creating an offer to buy it.
James K. Kim
James K. Kim (Jim) is a commercial real estate advisor with Pyramid Brokerage Company of Albany, Inc. in the Capital Region of New York, specializing in helping business owners expand into new locations or sell/lease a commercial retail, office, industrial, or investment property.