Insight 24
Do the Big Four Renos on a Rental Property—Now
Now that we've talked a bit about nice-to-haves versus must-haves, let's zero in the big four renos: heating and cooling systems, roofs, plumbing, and electrical. Experienced real estate investors will confirm: you can either do the big four right away or pay a lot more to have them done later.
Before we get into the specifics of the big four, let's quickly review the pay now/pay later rule of thumb, because it has obvious implications for virtually every aspect of the renovation process. What you need to think about here is the idea that more than money is at stake. As Warren Buffett said:
“It takes twenty years to build a reputation and five minutes to lose it. If you think about that, you will do things differently.”
The renovation decisions you make will have long-term effects on your investment. Those who go for the quick fix when doing a property rehab are playing with fire. The quick fix may lead to a quick buck early in your investment career, but the investors, brokers, contractors, lenders, and property buyers you need to make your real estate investment ventures a success over the long term will not stick with your team if you've got a reputation for sacrificing quality for speed. Good news travels fast. Bad news travels faster.
Make Sustainability a Fundamental Priority
Sustainability should always be the underlying fundamental when making decisions about how to handle a renovation. Whether your exit strategy is selling or a long-term buy-and-hold rental property, always do what needs to be done up front to get the job done right.
And never forget what's really at stake. If you cut corners on the initial property upgrade, you will either have an upset buyer or renter, a property that sits unsold or unrented, a ruined reputation, or an unhealthy combination of all of these things.
The Big Four
After undertaking hundreds of renos that were resold or held in rental portfolios, real estate renovation insiders emphasize that investors in the US foreclosure market have got to zero in on the big four: replacing or repairing the property's heating and cooling systems, roof, plumbing, and electrical systems virtually every time you add a new foreclosure property to your portfolio.
If you have ever owned or rented a home, you probably already know that these four items are the source of most of the problem calls from or to your property manager, landlord, or tenant. This happens because a lot of investors will try to deal with the big four by doing only minimal repairs, taking a band-aid approach because their initial renovation and repair budget did not make these four areas a priority, or they spent too much on the property itself and are now trying to squeeze a profit from a bad deal.
Always remember what's really at stake: your reputation and potentially your relationships with members of your investment team. While the United States is undoubtedly a big market, chances are you will be concentrating your investments in particular market niches, within specific geographic areas, so the reputation you build is important.
Heating and Cooling Systems
In many parts of Canada, residents can enjoy summer temperatures without ever feeling the need for an air conditioner. In Nevada, Arizona, Florida, and California, states with some of the best real estate investment opportunities in the United States, residential air conditioning is a fact of life!
In America, heating and cooling systems have an average life span of ten to twelve years. Be realistic. If you are buying a property that's a bank foreclosure, it's likely the system was not properly maintained by the property's previous owner or resident. One of the biggest problems is also painfully simple to solve: research shows tenants and property owners do not change out air filters every ninety to 120 days, the typical recommended time span, depending on the system. Filters literally cost only $2 to $5, but because the air handler is in a closet (out of sight, out of mind), they are rarely changed and often are not replaced for years. This basic lack of maintenance will destroy a system very quickly and can lead to a situation where the whole system must be replaced far earlier than its expected life span.
Given the potential for this expense to cut into his profit margins, an experienced real estate investor follows a specific rule in his approach to the heating and cooling systems. When he buys a property that needs to be rehabbed and the heating and cooling system doesn't have at least five years of life left (the manufacture date is usually on the handler and condenser), he will plan to replace the entire system and include that cost in his bid. If the system has five years of life left, he will, at minimum, plan to have the air handler and the condenser cleaned and serviced. He wants to make sure the system is working properly before he markets the home.
Roofs
North and south of the Canada–US border, roofs are generally the most expensive item to replace in a typical investment property rehab. Apply the same five-year life span rule used with the heating and cooling system to the roof: if the existing roof doesn't have at least five years of life left and shows signs of water damage on the interior ceilings, replace the entire roof.
If your roofer tells you the roof has five years of life left, have him inspect and seal or patch as necessary. In this scenario, always get a two-year roof certification, which will either guarantee his work or guarantee that the roof will not leak for two years.
Plumbing
Many foreclosed homes, especially if they are thirty years old or older, will have the original copper plumbing throughout the house. Given the degradation that can occur to these pipes, these homes will require a complete re-plumb of the hot and cold lines. Ignore this issue and you will pay later: ongoing plumbing issues are probably the number one expense in rental property.
To alleviate this expense, always factor in a complete house re-plumb during the initial renovation. This entails removing all of the original copper lines in the kitchen, baths, and utility rooms, and replacing them with CPVC. This is a plastic plumbing material that is non-porous and does not corrode or rust like copper, and is the material used in all new construction homes in the United States.
Electrical Systems
Again, this fundamental often applies to investment properties on both sides of the border, so it's nothing new to Canadians. Generally speaking, in any home that is thirty-plus years old that has been purchased as a bank foreclosure, you can expect to have electrical issues because the system may not be up to code.
In some states, a 100-amp service was normal in homes built thirty years ago when the typical home did not consume nearly as much energy as a contemporary household (there may not even have been dishwashers and washer/dryers, let alone microwaves and large heating and cooling systems). To meet the electrical needs of the contemporary home in the United States, you will need to provide a minimum 150-amp panel service. Make sure your investment team includes an electrician who can help you with budgets.
If the US homes you are looking to buy were built before the 1930s, knob and tube wiring may also be a significant rehab issue. Comprised of insulated copper conductors, protective porcelain insulating tubes and nailed-down porcelain knob insulators, these systems have been replaced by power cables. Because of the threat of fire, knob and tube wiring is considered an insurance issue, and is permitted under the National Electrical Code in only a few very specific situations.
Knowledgeable industry insiders say that if you buy and flip or rent a renovated home in the United States, you should upgrade the panel to a 200-amp service if the home is 1,200 square feet or more. This is a safety issue. You also need to make sure that all outlets within three feet of a water source (for example, kitchen and bathroom sinks) are grounded with GFI (ground fault interrupter) outlets. Any inspector will require this to pass code requirements. Remember, pay now or pay later. It's your choice.