SS276: When to Renovate Units—and When Not To

SS276: When to Renovate Units—and When Not To

Renovations can be one of the fastest ways to increase your property’s net operating income, but they can also destroy returns if performed incorrectly. In this episode, Charles discusses when unit renovations help the bottom line and when they are just vanity projects.


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Talking Points:

  • Renovations are one of the fastest ways for apartment owners to boost their net operating income and property value, but they can also erode your returns if you over-renovate or misjudge the timing of your renovations. The key is understanding when and how much to renovate. So, lets breakdown a few strategies our company uses.
    • 1. The Renovation Payback Period. We normally use a 36-month payback period on any renovations. This means that if the renovation costs $3,600, we want to make sure we can increase the rent on this unit by at least $100 per month so we are paid back within the 3-year window. Seems simple, right? But if the rent comps you are using or your renovation budget is incorrect (which has happened to me), this formula is thrown off. Make sure to use several nearby rent comps with properties that are very similar to yours. When it comes to the renovation budget, speak to a couple of contractors, especially if the one who has given you a quote has never worked with you before. 
      • From other episodes I have done, I mentioned that our payback period was a range of 36-48 months. Shooting for a 36-month payback is best; if your numbers are slightly off, you will still make the 48-month payback, but you want to avoid payback periods of 5-7 years. The only time I would use a 48-month payback off the bat is if the area is gentrifying really fast.
      • We want to catch up to the market with our renovations, not leapfrog it with new renovations that have not been tested.
    • 2. Renovating Units on the Turn. As units turn, this is where we want to perform our renovations. There are no tenant disruptions, and you can dramatically raise rents without upsetting a current tenant. 
    • 3. Testing Unit Demand. When you are turning units, there is no need to fully renovate every unit. Test different unit upgrades and renovations. We usually have 2-3 different finishing levels we are testing. A simple, clean paint and hardware/fixture upgrade, maybe one where we are also changing the flooring, maybe upgrading bathrooms, and a third where we are fully renovating the entire unit. Test how long it takes to rent the units, what the rent increases were versus the cost of renovation, and see which rents fastest and has the fastest payback period, and start doing more of those unit renovations.
      • A simple, clean, paint, and fixture upgrade will normally yield the best returns in most markets during an economic pullback, while if new professionals are moving in and looking for upgraded units, a full renovation might rent the fastest if few of your direct competitors are not performing these upgrades.
  • One important caveat with renovating and upgrading units is that we do not do this until all of the deferred maintenance has been corrected. Leaking roofs, plumbing issues, and HVAC problems are all corrected before we start upgrading. We also want to make sure our management issues are under control. If we are planning to switch management companies, are experiencing high delinquency, or are experiencing maintenance issues, we will correct this before we start upgrading units.
  • One of the key takeaways to renovating units is not to renovate units for beauty or vanity, but only renovate them for yield. Using several nearby comparable rent comps and verifying that you can be paid back within 36 months is always a safe bet for the level of renovation a unit deserves.
  • If you want to learn more about minor renovations that add a lot of value, check out episode SS219.

Transcript:

Charles (00:00):
Knowing when to renovate an apartment is just as important as knowing how much to renovate an apartment over renovations can kill your returns while not renovating your units enough. We’ll leave money on the table. Welcome strategy Saturday. I’m Charles Carillo. Today we’re breaking down when to renovate units and when not to. We’ll talk about the 36 month payback rule. How to use rent comps effectively while testing different renovation levels matters, and when a simple paint and fixture upgrade can outperform a full renovation. Let’s get started. Renovations are one of the fastest ways for apartment owners to boost their net operating income and property value, but they can also erode your returns if you over renovate or if you misjudge the timing of your renovations. The key is understanding when and how much to renovate. So let’s break down a few strategies our company uses.

Charles (00:44):
Number one, the renovation payback period. We normally use a 36 month payback period on any renovations. This means that if the renovation costs $3,600, we wanna make sure we can increase the rent on this unit by at least $100 per month, so we’re paid back within the three year window. Seems simple, right? But if the rent comps you’re using or your renovation budget is incorrect, which has happened to me before, this formula is thrown off. Make sure to use several nearby rent comps with properties that are similar to yours. And when it comes to the renovation budget, speak to a couple of contractors, especially if the one who has given you a quote has never worked for you before. From other episodes I’ve done, I’ve mentioned that our payback period was a range of 36 to 48 months. Now shooting for a 36 month payback is best.

Charles (01:29):
If your numbers are slightly off, you will still make the 48 month payback, but you want to avoid payback periods of five to seven years. The only time I would use a 48 month payback off the bat is if the area is gentrifying really fast. We want to catch up to the market with our renovations, not leapfrog it with new renovations that have not been tested. Number two, renovating units on the turn. As units turn, this is where we wanna perform our renovations. There are no tenant disruptions, and you can dramatically raise rents without upsetting a current tenant. Number three, testing unit demand. When you are turning units, there is no need to fully renovate every unit test, different unit upgrades and renovations. We usually have two to three different finishing levels. We are testing a simple clean paint and hardware fixture upgrade, maybe one where we are also changing the flooring, maybe upgrading bathrooms.

Charles (02:17):
And a third where we are fully renovating the entire unit. Test, how long it takes to rent the units, what the rent increases were versus the cost of renovations, and see which rents fastest and has the fastest payback period and start doing more of those unit renovations. It’s all testing. A simple clean paint and fix your upgrade will normally yield the best returns in most markets during an economic pullback. While if new professionals are moving in and looking for upgraded units, a full renovation might rent the fastest. A few of your direct competitors are not performing these upgrades. One important caveat with renovating and upgrading units is that we do not do this until all the deferred maintenance has been corrected. Leaking roofs, plumbing issues, HVAC problems are all corrected. Before we start upgrading, we also wanna make sure our management issues are under control.

Charles (03:03):
If we are planning to switch management companies, are we experiencing high delinquency or we’re experiencing maintenance issues? We’ll correct this before we start upgrading units. One of the key takeaways to renovating units is not to renovate units for beauty or vanity, but only renovate them for yield. Using several nearby comparable rent comps and verifying that you can be paid back within 36 months is always a safe bet for the level of renovation a unit deserves. If you wanna learn more about minor renovations that add a lot of value, check out episode SS 2 1 9. That’s SS 2 0 9. I hope you enjoyed. Please remember to rate, review, subscribe, submit comments and potential show topics@globalinvestorspodcast.com. If you’re interested in actively investing in real estate, please check out our courses and mentoring programs@syndicationsuperstars.com. That is syndication superstars.com. Look forward to two more episodes next week.

 

Links Mentioned In The Episode:

  • SS219: Transforming Properties: The Untold Value of Minor Renovations

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