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Rehabbing Rentals! In this episode of Discount Property Investor, our hosts, David Dodge and Michael Slane, continue their discussion on the BRRRR strategy and talk about Rehabbing Rentals. How to best rehab a rental. Lots of different options, only one way that makes sense. The way that makes sense by the numbers. You have to know your numbers and stick to them. Listen in and see what Mike and Dave have to say about Rehabbing Rentals.
Mike: Mike Slane, hey guys, welcome, thank you for joining us today. We are excited to talk about or continue our adventure on talking about rehabbing, or buying rentals–.
David: The BRRRR strategy.
Mike: The BRRRR strategy. So today we are going to be talking or delving into rehabbing. It’s kind of part of three episodes, we are going to chop it up to briefer segments. Today we are going to focus on really– what is rehabbing? How do you do rental rehabbing for your rental properties? As opposed to doing a major flip or rehab on your own house. What are some of the differences with what you’re going to do? What’s the purpose? All that sort of stuff.
So today– I honestly forgot until Dave told me today, why do we rehab our rentals? Well, I don’t know, it’s just what we do. Part of the BRRRR strategy, right? Buy Rehab, Refinance, Rent, Repeat, you know? That’s just what you do. So Dave you told me, you reminded me this morning what that real reason is. So what is the reason you buy a rental and rehab it? Why would you do that? Why would you invest more money into a property that you are going to have as a rental?
David: That’s a great question, Mike. Before I jump into that, I just want to recap on the BRRRR strategy. Buy, Rehab, Rent, Refinance, Repeat. So everyone of these steps in this process is very, very important, okay? So today as Mike had mentioned, we are going to talk about rehabbing. But in order for you to rent the property after you purchase it, you are going to rehab it 9 times out of 10. In order for you to even get a refinance that is favorable, so you can continue your BRRRR strategy, you have to rehab. So if you are buying a property that doesn’t need a rehab, it is going to be very difficult to convince your banking partners to give you a refinance again that is favorable to where you can get all or most of your money back, okay? So Mike had a really good question, why do we rehab? Well there are a couple of reasons.
Mike: Yeah and one that Dave even said is like– well you are going to have to rehab it. So why rehab? Why, Dave? Why not just buy a nice house? I’m not going to need to rehab it. Like Dave said, you could do that, but again– you are not going to be able to refinance if it’s already fixed up, it just doesn’t make sense for one reason. Whenever we do our rehabs, our banking partners require us to spend at least $15,000 on our rehabs. The reason that they do this is because– and they refer to this as giving us an entrepreneurial credit. Meaning that whenever they are doing their underwriting, it gives them the ability to look beyond just the cost of the purchase, so what you paid for the property, as well as the cost of the renovations, or the cost of the rehab. Typically whenever you go get a loan from a bank on an investment property, okay? This is not a primary residence, this is not a secondary home, this is investment property. They are going to give you a loan based upon the purchase price, and the cost of those renovations. However, if you spend at least $15,000, or at least with our banking partners, they looking beyond those two numbers. At that point they are– willing is the right word, to lend you based upon the appraisal and the appraisal only. So why does that matter, Mike?
Mike: This is huge!
David: Why are those numbers–.
Mike: This is magical. This is what makes real estate such a powerful tool. One of the other things that makes such a powerful tool–.
David: That’s right.
Mike: Let’s just run a quick example. Let’s say we purchased a property, and– I am going to digress a little bit. I am going to say first off, I want to reiterate what Dave said; we are buying properties that need work, which is awesome because then we can buy them at a discount.
David: A, we can buy them at a discount, and B they need rehabbing, which is almost kind of requirement in order for us to use the BRRRR strategy to the full potential.
Mike: What it allows us to do then is buying these properties at a discount that need work, is we are able to add value above and beyond just the material cost and effort put into those properties.
David: Every dollar we put in we are getting two dollars in value.
Mike: Hopefully, doesn’t always work that way, but that’s the plan. So let’s just use a quick example. Say we buy a property, and we say this house is a little three bedroom one bath. It probably is worth $100,000 at the end of the day– once it’s fixed up, that’s what properties in the area will sell for when it’s fixed up, a nice little property. We are able to pick it up for say $60,000, the kitchen is outdated, the bathroom is outdated. It looks pretty bad. Again, we are able to buy it at $60,000 off market, then we say, okay what can we do with it? We can fluff it up, we can do a quick rental rehab on it. Maybe spend $20,000. So we are going to be into this property for $80,000. It’s going to be worth $100,000.
David: At least.
Mike: On paper at the minimum.
Mike: So again, because we are doing a quick rental fluff up, we are going to spend a little bit less money. So it’s going to a renter as opposed to a new home buyer. You are not going to do all the same things in the rehab. But, you are going to make it look pretty close. You are going to make it look as good as. Again, it doesn’t have to be perfect. If you have a little bit of an older roof you don’t necessarily have to replace that roof, but you are probably going to get a pretty similar appraisal value. Whereas if you were going to sell it, you might have to replace that roof. So again, there are just these slight differences where you can add value to the property, very exciting stuff, very cool
David: So grade of the rehab is very important. If you are buying a property to flip, meaning you are going to rehab it to retail it, the grade of that rehab as Mike mentioned; it needs to be higher. You are probably going to need to swap out cabinets. You are probably going to need to do that roof, so on and so forth. But when you are dealing with a rental property, if you have cabinets that are maybe a little old, but they are perfectly in good condition; instead of ripping all those out, you can paint them or add new hardware. There’s definitely– corners you can cut, or costs that you can just avoid.
Mike: Here’s a great example. So we can talk about the grade of the rehab like you said, that’s the roofing thing. If it’s 15 years old, it still has half its life left. But again, a new home buyer would be like– the inspector is going to point out there is some [00:07:40.24 – inaudible], we are going to need this roof replaced and stuff like that. So it’s a whole different game, whereas you have probably got 15 years worth of life left in that roof, you don’t have to replace it.
Mike: Talking about the kitchen, this is a great one, Dave. You mentioned the cabinets, you can paint them up and that’s going to save a huge about of money if they are in good shape. I just walked through one of our properties yesterday where the cabinets look great. You look up underneath the sink and it’s all rotted, got some black, some mold under there. So again it’s like oh man, this is a rental, I am not going to replace the whole cabinet. I am going to cut out the boards underneath the sink, we are going to replace that board and make sure it doesn’t leak anymore. So again, you have got a nice brand new– you can paint inside there as well.
David: You know what I saw recently, Mike? Some people will make trays and leave the rotted board in there. They will use a plastic tray, you can buy them– Brad actually builds his own. He just puts these trays in and he screws the tray in. Therefore it makes it look pretty again, but also if it leaks again, it’s not wood there– he uses like a PVC type of plastic, really interesting.
Mike: We should start doing that, that’s a great idea.
David: Lots of little tips and tricks, guys, that you can use to kind of make short cuts. We are not saying cut corners to be— to make the product less quality, we are just saying you don’t need to go in and spend crazy money on it if it’s a rental property. So another thing that we had– reasons to rehab was– you want a hassle free unit. Mike, why does that even matter? What’s important about a hassle free unit?
Mike: So hassle free unit, what does it even mean first off, well the first thing is you have tenants in there, I think we can all– we have all heard that terminology in the investing world, it’s tenants toilets and taxes. Those are the three things that are a hassle when you’re a landlord and you buy and own properties, tenants, toilets and taxes. So what does that mean? Well the tenants, they are always going to be late paying rent, or have an issue with whatever. The toilets is talking about property maintenance. So your objective when you are rehabbing this unit, you are in there, it’s your opportunity to make this house bullet proof. You want to make it hassle free for yourself. You want surfaces what wipe down clean so they can’t really mess everything up. You want things that work. You don’t want to put the lowest grade plumbing fixtures. That is one of the big things, oh I can cut costs and put in a $20 sink–.
David: Or shower head, but it’s going to be broken in four months.
Mike: Exactly, it’s going to start leaking and spraying water before you know it. Again, some of those things it is worth spending the extra money on to prevent a maintenance call. How much is it going to cost you just to send out a handy man or a plumber to go replace a shower head?
David: It’s a great point.
Mike: It’s $200 that you save–.
David: Really you have two options; one, you can do all the work in the beginning when the unit is vacant, or right after you buy it and before you rent it, or you can do minimal work, but then you are going to be coming back a lot doing these repairs. So Mike and I, we prefer to do it right from the beginning. Therefore– there is always going to be maintenance, we are not eliminating maintenance by any means. But the goal by doing the most amount of work in the beginning, and trying to do it right, is to eliminate or reduce maintenance down the road.
Mike: Again, it’s a win win situation. Win for you because you are not having to deal with those calls, win for the tenant–.
David: Because they are not having to make the calls.
Mike: Because they are not having to make the call, and they are not having to live with– oh my AC went out, or oh my sinks backed up, or oh my toilet is over flowing. These are issues, these are problems, guys. You don’t want your tenants to deal with that either. They would rather live and stay in a nice clean place for the most part. So same thing– oh and the win for you again is the refinance portion of this which is the next step, which is if you spend the money upfront, you factor that into your initial–well not your initial purchase but your initial refinance with the bank. So then you don’t actually have as much money in the property or that money out lay later on. So then you can cash flow–.
David: That’s a good point, Mike. We didn’t even mention this in our notes here, but the quality of your rehab has a lot to do with the appraisal. So if you go into a quality and you don’t rehab it, or you do and spend three to five grand on that rehab, well when the appraiser comes out, he is going to be appraising, which really just means giving his opinion of value on what that home is worth. So what he is going to do is he is going to find like homes at like conditions to comp that property. So if you do spend 15 or 20 grand, in our case we try to spend at least 15 thousand, okay? Because what happens is we have improved the property, therefore when the appraiser comes out, he is now looking for comps that are equal to an improved property. So there is definitely a lot that goes into it there in terms of– do a decent rehab on all your rentals.
Mike: What it comes back to, Dave, is knowing your numbers.
David: That’s what it all comes back to, you’re right, knowing your numbers, it is such an important thing we need to highly emphasize and stress.
Mike: With rehabbing you need to know your numbers, with this BRRRR strategy you need to know your numbers–.
David: With this business, very difficult to be good at if you don’t know your numbers.
Mike: Which is why I love wholesaling. I am going to circle back to where we both kind of cut our teeth on full time investing which is wholesaling.
Mike: You kind of jump in, you really do learn your numbers, because you have other people walking the properties hopefully with you, or giving you feedback on the properties that you are marketing and trying to buy and sell. So knowing your numbers is extremely important. The hard truth is a lot of times until you do your first rehab sometimes you are just not going to know. So our objective is to try and provide you with as much value as we can, and hopefully keep your from making the bigger and more costlier mistakes.
David: Absolutely, so next guys, know your area. Mike just mentioned know your numbers, super important in all aspects of rentals, rehabbing, refinancing. The entire BRRRR strategy is built on knowing your numbers. Next is know your area, why does that matter? Well here is why. We just talked about doing a rehab to a property to increase its value so an appraiser then looks at comps that are like that. Well in certain areas of town, at least in our town and I am pretty sure it is the same in your town. You are are going to have certain parts of town that have nicer comes, and certain parts of town that have lower end homes. So you want to model your rehab to match the homes in that area that are going to comp out higher. Again, so kind of rolls back into knowing your numbers. But here is a good example. In our area, in St Louis Missouri, the north county part of time is really great for rental properties. The numbers seem to work there more often than they do in any other part of time. When we go into these houses, we are not spending 50 or 80 grand on the rehabs, we are spending 15-25 on average. The reason is, is that’s what it’s taking in terms of cost to get our property to comp out to where it works with our numbers. So know your area, certain areas will require more expensive rehabs to comp those properties out, and other areas won’t, okay? So let’s do a recap on what we have talked about so far. We talked about the reason to rehab, getting this entrepreneurial credit. Again, this is what our bankers are telling us. So this is their requirements. When you go meet your banker, they may have a different requirement. But when you sit down with them, tell them that you are using the BRRRR strategy. Tell them that you learned about this strategy from David and Mike at the Discount Property Investor podcast. Maybe they will come listen to it. If they don’t know much about it, they will learn to. But a lot of bankers out there are very familiar with the BRRRR strategy. In order for them to give you a loan based on the appraisal and the appraisal only, they have to consider an entrepreneurial credit, which is banking language in order for those under writers and their due diligence to plan out, or to play out properly.
Mike: I would also– a big [00:16:24.07 – inaudible], I think it takes time to develop a relationship with a bank. If you are just starting out and this is your first one, you may not get that credit right away.
David: You might not get it at all. I think it took us at least ten units, or ten houses before our banker even kind of told us about this. Kind of a hidden secret of things among these bankers.
Mike: We didn’t even realize it that it was what they were doing. They were looking– again at the appraisal, they always have the appraisal, they have to. But you always have to submit to the bank for your refinance all your numbers. They want to see, what did you buy it for? How much did you rehab it for? They want to know all the details, so then they can kind of figure out what to land on the property.
Mike: Like Dave said, it did. It takes a while to build up that relationship before they kind of say, oh okay you guys are doing this, you guys know what you’re doing, we have a track record of payments.
David: Look atit as trust. You are building trust with your bank. It may take five to ten units to get the trust on the level where the bank says, hey you are no longer high risk for us, as long as you can prove you have spent 15,000 on the rehab, then we are willing to look past all the minor due diligence issues because we have built trust. At that point, hey what is it appraised for? Here is what we will lend you on it.
Mike: A lot of times we don’t even want the full amount that they will lend us.
David: Correct. A lot of times we say, here is what we need to pay our lenders back, and it may be less than what the bank will be willing to lend.
Mike: Right, because again, we are after cash flow. It is all about knowing your numbers. We want to have a rent that is going to pay the mortgage, pay everything else, pay the property manager, the taxes, the insurance, all that stuff. Then also provide us with a little bit of cash at the end of the day. So if we take out a really big mortgage, we may not be able to have that cash flow. So it doesn’t make sense from our perspective either.
David: Got it. The reasons to rehab, you want the entrepreneurial credit, and this is really what makes this strategy work is this entrepreneurial credit. You want a hassle free unit. So rehabbing the unit in the beginning, versus trying to do a ton of maintenance later creates hassle free or less hassle. So that is another very good reason you want to rehab. The grade of the rehab. Again, we talked about knowing the area of town, that is going to affect things. Also knowing your numbers, how much do you have available to spend. What do you need to spend in order to get your comps from your appraiser to get them where they need to be? Don’t overspend, don’t underspend. You have to figure out where that line is to have a projection.
Next I want to dive into a live bit, if you are going to GC this project on your own, or if you want to hire a GC. There is no right or wrong answer with this. Both ways work great, but there are obviously advantages
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