Welcome back to our Property Walkthrough Series. In our first video, we talked about my five year hold on this property and looked at renovations. Today, we’re talking about the different options I had for rehabbing and the different options for financing the rehab on this house.
This blog post is the second on this property. The first blog post (and video) which includes before and after photos can be found here – Property Walkthrough – Five Year Hold on a House in the Springs.
- Watch the YouTube video (at the bottom.)
- Read the blog post. Note, the blog is an executive summary. Get the in-depth breakdown from the video.
Over the past couple of years, this neighborhood in Colorado Springs has seen a fair amount of growth. With the improved downtown, new soccer stadium, and Denver Biscuit Company, there’s a lot of good stuff popping up around town. There are newer builds going up which indicates a growing area and translates into more rent potential. My house wasn’t as updated as it needed to be to command a significantly higher rent, and that’s what sparked the idea to renovate it in the first place.
When my husband and I first bought the property five years ago, we did a lot of the rehab work ourselves. As investors, we’re always cautious about over-improving a property. But now that the neighborhood is changing, making big improvements to property will allow us to capture the changing rent trends.
What are my options for rehabbing my rental?
We had three different rehab options to choose from: super high end, mid-grade, or a regular turnover. We don’t think the neighborhood is quite to the highest end yet, and a simple turnover wouldn’t allow us to increase rent very much. We went with the middle option, though in reality the renovations are more of a mix of middle to higher end choices.
What are my options to finance a rehab of my rental?
Our financing options for the rehab are based on the level of work we’re doing on the home. In general, we have three different options: max leverage through a cash out refi, using cash on hand, or doing nothing.
Doing nothing would mean spending a minimal amount of money on tenant turnover, such as repainting, fixing doors, and minor landscaping. It would cost a few thousand dollars and would only allow us to increase rent by $50-100. Since we decided not to go that route, it was eliminated from our options.
A cash out refi usually makes the most sense on paper. We budgeted around $20K for the renovations, which we could easily pull out using this approach. Assuming a 4% interest rate, the mortgage would go up about $100 a month since we pulled out money. We would be able to increase rent by $300 with the renovations, which means we’d still be making more money overall. It seems like a no-brainer, but there are other factors that come into play.
Our current high-3’s interest rate is really good, and since interest rates are increasing, I know we aren’t going get a better rate. We’d also have to pay closing costs, which are several thousand dollars. Plus, going through a refinance is a headache that I don’t want on my plate.
The other option is using cash on hand to finance the rehab. I have $20K in reserves that I can use to finance the rehab, so I look at it as an investment. I’m paying that amount to get $200-300 more in rent per month, which is about $2400-3600 a year. This gives me a 12-18% cash on cash return.
The downside of this approach is the opportunity cost—I can’t use that cash to purchase another property. Even though I’m putting this money into my property, I’m not getting the additional benefits of a new property, such as an appreciating asset and tax incentives.
For me, using cash on hand makes the most sense because I’m happy with my current portfolio and don’t want to add to it right now. I’m at a point where I’d rather keep what I know and get my returns by doing this project, so this was an easy decision for me.
Advice to First-Time Real Estate Investors
When my husband and I purchased this house five years ago, we were nervous, beginner investors. If I could talk to my past self now, I’d tell her not to worry. We couldn’t envision being in our current position—choosing from rehab options that all make sense financially, equity to tap into, and the experience of holding and managing the property.
For all beginner investors out there, I have the same advice. If you’ve already run the numbers and you know that your property makes financial sense, be patient and don’t worry. If you invest right, your property will appreciate over time and you’ll be moving toward your goals.
I know now that my initial estimate of $20K for the rehab is out the window, but that’s why I have cash reserves. Cash reserves help you sleep at night, so make sure you factor them in, too!
Once all of the work is done, I’ll have better numbers and what this project actually cost, so stay tuned. And in the meantime, if you’re interested in investing in your own property, reach out to us. We’re happy to help you form and plan and find the right property for you.
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