One job of a landlord is to makes decisions on repairs and improvements. Typically, repairs have to be done as they make the unit habitable (e.g., a hole in the roof). However, improvements are a different story as they are not always needed to make the unit habitable, rather they usually add value to the rental with the goal of attracting/keeping a great tenant and/or getting a higher rent. With regards to improvements, a landlord need to find that balance between improvements that are economically beneficial and those that are not, which begs the question, “How?”
I have seen many properties with old carpet, drab looking paint, and worn-out cabinets that were in desperate need of improvements. Without doubt, the condition of these units deterred great tenants and prevented the units from being able to produce the rent that it was capable of producing. Ultimately, improvements in this area usually would result in a great financial benefit to the landlord.
Conversely, there are plenty of times when an improvement is too extravagant and does not add value to the unit commensurate with the cost of the improvement. For example, in a number of my neighborhoods, an expensive chandelier would not add value to the property as the average tenant would not be willing to pay extra rent to get a fancy chandelier. In other words, improvements like this would be a waste of money.
So, for every landlord it comes down to knowing your market and knowing what the tenants in your market want and what they will pay to get. As I stated, In my markets, chandeliers do not command higher rents like sharp looking floors, fresh paint and a newly glazed bathtub do. So, I focus my resources on the latter and leave the former for someone else.
Which leads to the question, how can one figure out if an improvement is worth the increase in price? Let’s go through a little example to find out. In this example, we follow our old friend Stradlater, who has a rental unit that just became vacant. Stradlater plans to continue to own the unit for another 5 years. The unit was previously occupied by a tenant who was long term, the unit was left in OK shape, and it could be rented out in “as is” condition for $750/month based on comparable units.
However, if the unit was rehabbed from top to bottom it would cost Stradlater $9,000 and would result in the property renting out for $1,000/month. Should our friend Stradlater simply rent it “as is” or make the improvements and get the extra rent? To answer this, we need to turn to our trusted financial calculator.
Answer: (Enter the following numbers into your HP10bii financial calculator) If you don’t have one, no worries, simply follow along)
N (number of months)= 60 (we know that Stradlater is planning to own the unit for 5 more years)
I/YR (interest rate/year) = ??? (This is what we are solving. We have to figure out if the investment into improving the unit will give Stradlater a good return on his money)
PV (present value) = ($9,000) (this is the amount that Stradlater will invest into the property to get the increased rent. Notice that this number is negative as Stradlater is losing access to the cash in return for getting the increased cash flow)
PMT (monthly payments) = $250 (Stradlater will get an increase in $250/month if he does these improvements)
FV (future value) = 0 (there is no big payout at the end of the 5 years)
After entering the above numbers, the answer comes out as 22.28%. This ultimately means that if Stradlater invests $9,000 into improving his unit, and it results in an increase in rent from $750 to $1,000 per month, that would result in his return on investment being 22.28%, which is a heck of a lot better than the return he would get from a CD. So, Stradlater, ultimately has to decide whether he feels the return of 22.28% is good enough for him or if he has a better investment opportunity for the $9,000.
As I have discussed on a prior blog, I believe that it is very important to have units that look sharp to get properties rented out fast to quality tenants, and part of doing that is knowing what improvements to make and which to skip. I hope that this blog and example help to give you a road-map on how to see if an improvement is a good investment and ultimately worth the expense. How do you look at improvements for your rentals? What improvements do you think are necessary for any rental? I would love to hear your feedback below.
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