Renovation – Upgrading Cost Analysis
Renovating and upgrading an investment property acquisition is a source of both opportunity and risk. When a property has deferred maintenance, the cost of curing the deferred maintenance can be difficult to estimate without obtaining bids from contractors. Upgrading a property is an excellent option for enhancing investment returns. However, selecting which areas to upgrade and confirming, through analysis, their financial feasibility can be a time-consuming project.
Preparing a plan for renovations and upgrades is a complex project and needs to be integrated into the investor’s overall plan for the property. Consider the following examples of planning for renovations:
- Should an investor repair or replace the roof on an office building which is being acquired as a land play? The investor expects the building will be demolished within five to seven years but wants to maintain the income stream during the holding period.
- Should an investor patch potholes or do a complete overlay for a class C apartment complex? The cost of patching is $20,000 while the cost of a complete overlay is $150,000. The investor plans to maintain the property as a class C apartment complex for the indefinite future.
Upgrading an income property often offers the investor an excellent rate of return. In many cases, the existing investment group is complacent and does not want to expend the capital nor take the risk to enhance the performance of the property. An ideal time to plan renovations is prior to completing a plan for the capital structure and total amount of capital required during the due diligence period. In many renovation cases, the lender will fund most of the cost of the upgrading if it is planned prior to the acquisition. Otherwise, the investment group will likely have to fund the cost of the renovation if it is done at a later point in time.
Following are a limited number of options for property upgrades:
- Upgrade the unit interiors for apartments by adding granite countertops, crown molding, better quality cabinet fronts and replacing drawer pulls. Other options are upgrading appliances, carpeting, bathrooms, lighting and plumbing hardware.
- Modify the lobby and elevator cabs for the property with a plain appearance.
- Upgrade the lobby, elevator cabs and common areas.
- Replace and improve the facade and signage for retail strip centers and other types of retail.
- Review upgrading signage and landscaping, particularly near the leasing office.
- For industrial properties, consider adding cranes, parking area, stabilized yard area and expanding the truck aprons.
The tentative plans for completing renovations and upgrades are developed by reviewing rental rates, the quality of rent comparables and through interviews with property managers, leasing agents and property owners. In some cases, property managers and owners for competing properties may be more comfortable discussing these issues with an independent appraiser or market analyst than with a potential new competitor.
The next step is to obtain construction cost bids for both deferred maintenance and upgrade options from local contractors. Depending on the size of the item, multiple bids may or may not be necessary for the purpose of determining a probable cost during due diligence. Once the acquisition has been completed, multiple bids for many items are often appropriate. (Either O’Connor or the client can obtain these bids.)
After obtaining cost data, the appraiser/market analyst is able to determine whether the contemplated plan meets the investors financial objectives. In most cases, the renovation and upgrading plans are scrutinized for opportunities to reduce cost and enhance yields after obtaining cost data.
The final step is to consult with the client regarding options, our analysis and conclusions. Reporting options vary from a verbal report to a detailed narrative report.
By researching upgrade options the investor can maximize their return. Obtaining construction costs mitigates the investor’s risk and makes it less likely he will need to explain to partners/investors why renovation costs sharply exceeded the budget.
O’Connor and Associate’s staff complement of over 50 real estate professionals can plan the appropriate level of renovation / upgrading and obtain construction costs. They can also handle other due diligence tasks. These professionals are supported by an experienced staff of over 100 who are accustomed to complex assignments. Our team has experience in all aspects of real estate including acquisitions, due diligence, ownership, appraisal, property tax appeals and dispositions. Reduce your risk and stress by utilizing O’Connor and Associate’s breadth and depth of experience to evaluate your real estate investments.