For new real estate investors, estimating home rehab costs poses a major challenge. And, this estimate can make the difference between closing a deal or letting it go. As such, new investors often ask me: Ryan, how much does it cost to rehab a home?
This depends on the type of property. But, I have cost per square foot rules of thumb for the type of rehab you’re doing. These numbers let you decide whether to put a place under contract. Then, you’ll walk the property with a contractor to confirm the final rehab numbers for your deal budget.
In the rest of the article, I’ll explain these home rehab rules of thumb and other considerations. Specifically, I’ll cover the following topics:
- Why Rehab Estimates Matter
- Home Rehab Cost Considerations
- Rehab Cost Rules of Thumb
- From Rehab Estimate to Final Numbers
- Using the Advanced Deal Analyzer to Determine Profitability
- Finding Rehab Deals with Investor’s Edge
- Final Thoughts
Why Rehab Estimates Matter
Home renovations play a central role in two common investment strategies. And, understanding these strategies lays the foundation for understanding why home rehab estimates matter so much.
Fix & Flip
With this strategy, investors find distressed properties to buy, typically at a deep discount. But, due to this distressed nature, these properties do not qualify for traditional mortgage financing. Traditional lenders require ready-to-occupy properties to secure their loans, so properties in need of significant renovations do not qualify.
Instead, fix & flip investors use either cash or a hard money loan to both purchase and renovate the properties. In particular, this strategy entails renovating a home to sell at retail, generally to people looking to purchase a primary residence. As a result, these buyers use traditional financing, and they need properties to qualify for this financing. Simply put, fix & flip investors use the rehab process to take a property from not qualifying to qualifying condition for traditional financing. This allows primary homebuyers the opportunity to purchase these homes.
BRRR
BRRR investors take a similar initial approach to house flippers. But, they have a different ultimate profit model. More precisely, BRRR investors follow the below steps:
- Buy: These investors look for the same type of properties that fix & flip investors seek, typically distressed homes for sale at a deep discount.
- Rehab: Next, BRRR investors rehab these distressed properties. However, whereas fix & flip investors rehab to sell, the BRRR model renovates properties to rent. As a result, these investors need to rehab properties that A) appeal to potential tenants, and B) use durable enough materials to withstand the wear and tear of a rental property.
- Rent: Once fully renovated, BRRR investors rent their properties to high-quality, long-term tenants. Of note, this long-term aspect plays a critical role in the next step.
- Refinance: Similar to house flippers, BRRR investors generally finance their purchase and rehab with high-interest, short-term hard money loans. This means that, once rented, they need to refinance these loans into long-term, lower-interest permanent financing, or “takeout” loans. As an established landlord, a lender will likely consider a portion of a property’s rental income towards the investor’s overall debt-to-income ratio. But, this requires a signed, long-term lease. And, once refinanced, investors profit three ways: 1) cash out from the refinance (potentially); 2) cash flow from the tenants; and 3) long-term property appreciation.
Why Do Home Rehab Estimates Matter For These Investors?
Now that I’ve outlined these two strategies, the question remains, why do home rehab estimates matter so much to these investors? Really, the question to ask is, how do I know how much to offer on a property?
House flippers and BRRR investors need to have a rough estimate of a property’s rehab costs before making an offer on the property. For house flippers, profit equals the final selling price of a renovated home minus all costs (i.e. purchase, rehab, holding, and transaction costs). For BRRR investors, the rehab costs and purchase price need to be less than the takeout mortgage amount, otherwise the refinance won’t pay off the hard money loan balance.
Accordingly, it’s impossible to project a deal’s profitability – and whether it’s worth pursuing – if you can’t estimate the rehab budget. For example, a potential deal may have a $50,000 profit at $100,000 purchase price and $50,000 rehab budget. But, what if the rehab budget is actually $100,000? Then, you’ve just eliminated the profit on the deal. As a result, you’d need to make a lower purchase price offer for the deal’s numbers to make sense.
Bottom line, if you can’t estimate a deal’s rehab costs, you can’t develop a rational offering price. And, you can’t realistically take a contractor to every potential deal you consider to develop a detailed bid. No contractor would be willing to do this – when would they have time to actually work if they were running around developing detailed bids all day?
Instead, investors need a quick, back-of-the-napkin method to estimate a property’s rehab costs. With this information, you can make an informed decision about how much to offer on the property. Consider this the first hurdle in a deal. If, with this estimate, the numbers still make sense, you should pursue the deal and put the property under contract.
Once you place the property under contract, you can use the due diligence period to develop a full scope of work and detailed rehab budget with your contractor (more on this below). And, you can use these final numbers and the associated contractor bids as leverage to renegotiate the contract price, if necessary.
Home Rehab Cost Considerations
Now that I’ve stressed the importance of home rehab estimates, I want to talk about different cost considerations. Not all home renovations are the same, and the cost will largely depend on the type of property. For instance, sprucing up a rental property will have a far different budget than a total remodel of a high-end property – with an entire spectrum of options in between.
For example, with the same square footage, I could spend $1,000 or $5,000 on a carpet installation, depending on the quality of the material and labor. Or, what about countertops? The materials for countertops can vary widely. On the high end, you could pay $250/sq. ft. (or more!) for marble countertops. On the low end, you can buy laminate countertops for as little as $15/sq. ft. Now, I’m not suggesting that you should put marble countertops into rehabbed homes, but I use this massive price variance to illustrate the factors that can influence a total rehab budget.
Rehab Cost Rules of Thumb
Estimating rehab budgets poses a challenge to new real estate investors. And, I faced these same challenges when I was beginning, too. As such, I’ve used my experiences to develop some rehab cost rules of thumb. I use these numbers to develop rough rehab estimates, which I then use to inform my decision making on how much to offer on a place.
Each of the below numbers corresponds to a particular type of rehab:
Rental-type Rehab – $10/sq. ft.
Think of this as a value-add rehab in a rental property. In other words, the property is largely habitable, but it definitely needs some TLC to make it more appealing to potential tenants.
Assume it’s a 2,000 sq. ft. home. With this rule of thumb, I would estimate a rehab budget of $20,000 (2,000 sq. ft. times $10/sq. ft.).
Light Rehab – $14/sq. ft.
Next on the spectrum, you have your light rehabs. These properties don’t need a ton of major work done – but more than the surface-level, rental-type rehab.
Continuing the same example, I’d budget $28,000 for this sort of rehab.
Medium Rehab – $26/sq. ft.
After light rehabs, you have your medium rehabs. These typically need more work, require higher-quality materials, or a combination of the two. And, these requirements boost the total budget estimate.
Rehab estimate: $52,000.
Heavy Rehab – $37/sq. ft.
At the far end of the spectrum, you have heavy rehabs. These are the high-end rehabs requiring a lot of work and top-notch materials.
Rehab estimate: $74,000.
As these estimates illustrate, a 2,000 sq. ft. space could have an estimate ranging anywhere from $20,000 to $74,000, depending on the type of rehab you need to do.
From Rehab Estimate to Final Numbers
These estimates are just that – estimates. They allow you to assess a deal’s merits and develop a reasonable offering price, but you eventually need to refine estimates into a final budget. Broadly speaking, you’ll take the following steps after you go under contract.
Home Rehab Step 1: Develop Detailed Scope of Work
First, you need to develop the detailed rehab budget numbers. I recommend doing this by walking the property with your general contractor (GC). As you walk the property together, you’ll talk about everything that needs to be completed during the rehab process. And, you need to document each one of these items. As the investor, you are ultimately responsible for the deal’s budget and execution – not your contractor. Personally, I like to record these conversations on my phone, as I can use this as a reference when I’m building the below scope of work.
Once you’ve completed the walkthrough, you’ll document every single item in what’s known as a scope of work form. This form will include a line-by-line description of every task to be completed, the quality of the associated materials, and – eventually – the cost per item.
NOTE: At Do Hard Money, we have detailed scope of work form templates. And, we have project managers who support our investors through the entire process, as we understand developing and executing a rehab plan can be challenging.
After you’ve added the tasks and materials to the scope of work form, I recommend meeting with two contractors to have a pricing meeting. During these meetings, you’ll assign costs to each of the line items in the scope of work. The total cost for all of these items becomes your rehab budget. And, meeting with two contractors for pricing bids lets you solidify a primary and back-up contractor. This will give you flexibility during the rehab process in case one of the contractors A) doesn’t perform, or B) needs to back out due to unforeseen circumstances.
Additionally, meeting with two contractors confirms you’re fair market pricing the project. You don’t want one contractor to significantly underbid and then request another $10,000 or $20,000 once the rehab begins. By getting two bids, you’ll have a clear picture of market pricing.
With pricing confirmed, both you and the primary contractor will sign the scope of work form. That way, if you have any discrepancies in the future, this form will serve as the final arbiter.
Home Rehab Step 2: Sign a Services Contract
After signing the scope of work form, you now need to sign a services contract with your GC. This contract outlines exactly how the GC will complete all of the items included in the scope of work. For planning purposes, I assume that for every $1,000 of rehab budget a contractor will need one day of work. So, a $40,000 rehab should take 40 days to finish, and then I add a 10-day buffer for standard friction (e.g. permitting delays, weather issues, etc.).
I also recommend dividing the scope of work items into key milestones. Normally, I’ll look at the project and create 25%, 50%, 75% and 100% milestones. This helps ensure the project progresses on schedule. And, in terms of payments, I will only pay a contractor for a scope of work item when that item is 100% finished. This keeps GCs on task, as they know they’ll only get paid when they’ve completed an item to standard.
To reiterate, you complete all of the above before you purchase the home.
Home Rehab Step 3: Renegotiate, Close, or Exit the Deal
Having signed the services contract and scope of work, you now have a detailed and accurate rehab budget. With this information, you can decide whether your original contract price makes sense. If it does, close on the purchase.
Sometimes, though, your detailed final budget comes in higher than your initial estimate. When this happens, the contract price may no longer make sense. In these situations, you can bring the final contractor bids to the seller, using them as leverage to negotiate a reduction in purchase price. Most motivated sellers will work with you and adjust the selling price. If not, you can still walk away from the deal with your earnest money, as long as you meet the due diligence period deadline.
Yes, you absolutely want to estimate your rehab budget as closely as possible, as this allows an accurate offer price. But, sometimes your final numbers just don’t align with your initial rehab estimate. As this section illustrates, it’s okay when that happens. The due diligence period outlined in your contract gives you the flexibility to A) confirm a final, detailed rehab budget, and B) negotiate the purchase price accordingly.
Using the Advanced Deal Analyzer to Determine Profitability
I touched on it above, but rehab costs only represent one portion of a deal’s profitability:
- Final sales price
Minus the total of
- Purchase price
- Rehab costs
- Holding costs
- Transaction costs
Equals
- Profit or loss
And, the other factors can seem as complicated to figure out as a rehab budget for new investors. As a result, we’ve created a house flipping calculator to clearly tell you a deal’s cost breakdown – and whether it’ll be profitable or not.
With our Advanced Deal Analyzer, all you need to enter is a property’s purchase price and rehab costs, and it calculates the rest. It’ll tell you A) whether or not a deal’s profitable, B) how much profit you can make, C) the hard money loan you can qualify for, and D) a detailed breakdown of all costs for the deal. When you combine this information with your rehab budget, you’ll know with complete confidence whether or not to continue a deal.
Finding Rehab Deals with Investor’s Edge
Now that you know how to figure out a deal’s rehab budget, the next question is: how do I find these deals? For investors, we highly advise against looking for properties on the Multiple Listing Service, or MLS. Too much competition exists for these properties, and they all tend to sell at retail, meaning you’ll struggle to find discounts that will allow for a profitable flip.
Instead, we recommend going after off-market properties. These inherently lack the competition of the MLS, and you can typically find far better deals. We’ve created a unique software to help you find these deals. With our Investor’s Edge software, you can instantly search through over 160 million potential deals, tailoring your search to dozens of personalized parameters. When you find an appealing property, you can market directly to the homeowner via postcards with pre-filled addresses or voicemails.
Final Thoughts
As outlined in this article, rehab costs significantly vary by property type and investment objectives. But, using the above rules of thumb, you can make realistic estimates, providing you insight into how much to offer for a home. And, I highly recommend that, if rehab estimates are close to aligning with your profit goal, put the property under contract. You can always back out once you’ve developed final numbers in the due diligence period, and you don’t want to miss out on a potentially great deal!
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