Guest post by Steve Belleville, Vice President, Real Estate Lending Group, Inc.
Property investors and lenders want to be able to review and analyze rehab/remodel deals in a timely manner to be able to act on the deal (or decide to pass on it). It may be a loan file or an investment purchase deal.
The following items are some key factors to consider and things to do for commercial and residential 1-4 unit properties. Yes, there may be more issues and factors, but this list will help get the thought process going.
Ten things to consider and watch out for
- Taxes, fees, and liens that run with the property. Resources for that information include: escrow/title officer, city or county official, local utilities, as well as web sites (i.e., http://publicrecords.netronline.com, www.criis.com, and county Web sites).
- What’s inside the walls? Issues inside the walls can be costly once the walls are opened up and expensive repairs are necessary (consider the age and condition of plumbing, electrical, insulation, and wood, as well as the presence or lack of sheer walls).
- Sagging/slanted floors. Are there cracks in the foundation, is it brick, or is it a slab foundation? Foundation and underground work costs $$.
- What about the roof? Is it a flat roof? Generally flat roofs have more drainage and leak problems. If pitched roof, is it ceramic tile? And can that tile be matched if repairs are done on it? Any visible stains or sagging in the ceiling? Budgeting for a new roof may be necessary.
- Condition of windows (new, old, single pane, double pane, SP sound rating and Low E energy rating). Upgrading windows can be a strong selling point as well as an energy cost savings measure. Look closely at the existing windows and surrounding walls for evidence of leaks. Ongoing leaks can cause dry rot and attract subterranean termites. These repairs add considerably to the expense of new windows.
- What is the age of the structure? Generally speaking, the older the building being rehabbed or remodeled is, the larger the budget becomes. When fixing one part, parts adjacent or connected to it often break and need to be replaced as well, or new code requirements apply and add cost. Sprinkler systems or seismic retrofit, which can be required for residential as well as commercial structures, are a good example of this.
- Environmental due-diligence. What was the site used for previously? Do any environmental issues exist above and below the ground (i.e., lead paint, asbestos, and other contaminants, or was the site a former gas station or dry cleaner?). There are companies that will come out and pull samples to test for those items as well as companies that will do an environmental screen report and/or Phase I or Phase II for commercial and Multi-Family properties. Listed are a few resources (a Google search will identify more): www.veracheck.com, www.odicenv.com, and www.edrnet.com/index.php.
- Location and market demand in the area, either as a rental or as a sale. Know the area – the upside market range and the downside market range as a rental and for sale.
- Time is money. How long will it take to get everything done? As part of the analysis, pad it, add time to it, and look at what happens. Is it still a good deal or is it a highly time-dependent deal?
- As-Is and As-Completed value. Work with a known appraiser that has expertise with the property type. The above watch list should be considered whether the strategy and intended use of the property is fix and flip, redevelopment, or a rental income property.
Further, as part of completing the analysis before getting started, below is a list of top items to do before getting into the deal.
Five things to do
- Identify the scope and budget of the project. What rooms will yield the highest return for dollar spent (i.e., kitchen and bathrooms) and what upgrades or repairs will bring the highest return? Work with an experienced developer and licensed contractor. It is best to have these relationships in advance.
- Have a contingency line item in the budget (say 10% to 15% or more in this environment). Bottoms up and top down. Be conservative and identify high, medium and low budget/profit outlook. There are Web sites that provide detail materials cost data. Funds control and funds disbursement companies can provide budget review input as well.
- Make sure a permit is in place (and any financing needed) prior to starting work as well as the proper insurance policy.
- If adding space, understand the size threshold for triggering higher city taxes and fees (i.e., in many cities, adding 500 square feet or more triggers an additional tax/fee for local schools). So, planning ahead and building only 498 square feet can save thousands of dollars in additional fees/taxes.
- Get an extra set of eyes. Looking at the deal with another set of experienced eyes helps identify things which may become future issues, driving up costs and/or taking more time to correct. It is a good idea to review the deal and walk through it with an experienced colleague, partner, or funds control expert.
Up front analysis, inclusive of key items to consider, and gaining input from experts can save time and money later. When the analysis demonstrates the strength of the deal–great! However, if the analysis doesn’t look or feel right, don’t do it. Look forward to the next opportunity.
Any companies or websites referenced are for example purposes only and do not represent any endorsement.