Maximize The Profits on Your Renovations
Take a True Look at Each Deal in Front of You By Rodney Mollen Renovating properties has been a tried-and-true method of creating investment value in real estate for decades. During up markets and down markets alike, there are always opportunities to create value-add profitability with a good renovation strategy. Finding the right deals presents one challenge for investors, while another key factor is identifying the best renovation for each property. During the downturn of 2008, I helped build and manage an investment firm that acquired over $1B in REO and NPL and generated a 29% compound rate of return on our REO deals over a 3–5-year period (do the math… that’s some serious lift in value). During those years, we would interact with other various investment institutions, most of whom held a different approach to creating efficiencies in their “scaled models” of renovations by attempting to save money by purchasing materials in bulk at wholesale rates and installing them in every one of their homes. In our view, these institutions were clearly focused on the wrong things … saving costs on elements of their renovations which were not actually providing a return on their renovation dollars in the form of increased property value or rental value. In our view, it was critical to identify how an investor would generate the optimal profits on each deal. Every property and every neighborhood face different dynamics, including supply/demand, buyer preferences, and architectural trends. Therefore, a universal approach to enhancing investment gains through renovations is ineffective. Instead, we believe in collaborating to enhance our collective expertise and elevate our industry’s profit-making potential. A Review of the Data On a recent analysis of 3,000+ Renovation Analysis reports by RicherValues, we found that borrowers were missing the mark on over half of all projects, overspending on 45% of their projects, underspending on 10%, and hitting the optimal strategy on the other 45% of their deals. How do we know? We quantify the economics for multiple renovation strategies side-by-side on every property we analyze, whether it’s our software clients who conduct analysis on their deals in real-time or it’s our FIRREA-compliant reports for our lenders. For each renovation strategy (min, partial, and full remodel, plus value-add expansions as applicable), we provide a powerful look into the dynamics of each deal to empower the investor to make decisions that will generate the best return rather than solely relying upon the advice of a contractor, realtor, or other potentially biased party. Once these metrics are in place, the optimal strategy is defined as the renovation that will produce the highest annualized return, and above a certain return threshold to offset risk. In our analysis of the 3,000+ loans, we compared the proposed budget that was submitted by the investor/borrower during the loan application to the hyperlocal data and analysis for their subject property. If the investor’s budget came in materially higher in scope and cost compared to the optimal strategy, then this loan was marked as overspending. If it came in at a materially lower level of renovation than the optimal strategy, this would be marked as underspending. And if the investor’s budget was within range of the optimal strategy, then we marked this loan as “they nailed it.” On 45% of loans (roughly 1,350+ investor loans), the borrower was targeting a higher level of renovation than the numbers recommended, and they were experiencing what is called “diminishing returns.” The additional “value-lift” they were achieving for the additional renovation dollars being spent began to decrease and, in some cases, turn negative. This means that in many instances, investors were spending more in renovation dollars than they were actually achieving in increased sale price. Not an ideal spot. The great news is that as an investor, you can perform this straightforward analysis on any one of your deals. It might take some work (or some good software) beyond what your realtor/contractor might submit, but if you follow this same approach, you can evaluate your deals to a deeper degree and start making the decisions that will put greater profits in your pocket. Why Conduct an Analysis The benefits of conducting an analysis include higher profits, faster projects and better returns, and faster loan approvals. Higher Profits As we explained earlier, the core benefit of this analysis is that it will help you understand where the “sweet spot” lies and how to unlock the highest profitability for each deal you pursue. You would be surprised. We have case studies where our investor clients at RicherValues found that a trash-out / clean-up with an As-Is Sale was actually going to be the most profitable strategy. While the investor was skeptical at first, they were thrilled when they made $30k more profit on their deal than they thought they would have made had they spent the time and money to complete a full renovation … and instead, they were in and out of their deal 3-6 months faster. More money, and in less time? Now that’s a win. Faster Projects and Better Returns Reducing the renovation scope of a project will almost always reduce the amount of time it takes to renovate. However, if a less-renovated property takes longer to sell in that hyperlocal area, then this does not always translate to a faster project. Both timelines (renovation duration and listing time) must be considered together to evaluate this. Nevertheless, savvy investors understand that faster turns of their capital translate to lower carrying costs and greater take-home pay. Faster Loan Approvals With the continued growth and improvement in quality and service across the private lending space, lenders who receive higher quality deals backed by deeper analytics and intelligence are much more likely to respond with excitement and approval as compared to investment deals that are poorly underwritten or might be based on overestimated ARV’s or incorrect renovation budgets. Put simply, higher deal quality can lead to closing more deals, with faster loan approvals and closing times. And as they say, time
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