Jan 12
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Earlier this week we unveiled the before and after pictures of our character home renovation project. And last year we shared pictures of a major renovation project we did where we added a legal suite. One of the best things about being a real estate investor is the opportunity to add value through improvements. And, done right, renovations can add more value than you put in, increase cash flow and attract better tenants or buyers. The only problem with renovating rental property: IT COSTS MONEY!
So how do you pay for your rental property renovations?
One of the absolute best ways to add value to a property is to make improvements that make the home ‘move-in ready’. Things like flooring, kitchen upgrades, paint and landscaping can improve the value of a home by as much as twice the cost of what you put into it – if you do it right. Another way to make a huge value improvement and boost cash flow is to add a legal suite.
But it doesn’t matter if you’re adding a suite or just putting in new flooring – it all takes cash. And sometimes cash is the one resource you DON’T have as an investor.
For us, the ideal scenario for a property that needs a lot of work is to find a seller that will carry the financing (in a VTB) for as much of the purchase price as possible. We would then raise the renovation costs through a short term private money loan or a line of credit.
We would then complete all the work, place a tenant and then refinance at the bank hopefully pulling out enough money to pay out the private loan and the VTB.
That’s the ideal scenario but in many cases we aren’t able to find a seller that agrees to carry financing – even for a short period of time. No need to quit if the seller won’t give you a mortgage. There are still plenty of options if that is your situation.
Options for Financing a Renovation if the Seller Doesn’t Carry Financing
1. Bank programs that will help you out with renovation costs (talk to your mortgage broker or bank to see if you’ll be able to qualify for any of their programs to fund the renovation or at least pull out some of that cash after it’s done; there are a lot of limits on these programs but if you can make it work it will probably be the cheapest money you’ll find for doing this type of project).
2. RRSP mortgage – when you borrow funds from someone’s RRSP to do your deals you have a lot more flexibility in what you do with the money. You have a lot more control over the terms of the mortgage and can decide what sort of payment schedule you want to offer the lender. You could fund 100% of the purchase price (although I personally would never recommend a lender agree to this for their own security – you CAN do it and given that you’re planning to add value through a renovation it might be feasible).
If you have a property with a lot of equity in it, you can put a second mortgage on it using arms length RRSP funds (arms length just means that you are borrowing from someone that is not your spouse, child or parent). This is what we did for the ’70′s house renovation project we tackled last year. We negotiated a balloon payment at the end of term and the ability to repay it at any time with no penalty. This allowed us to use the funds for the renovation without the pressure of having to make monthly payments at the same time. Once we pulled the money out after refinancing we still had the funds to use so we put them into another property and eventually paid it out when we sold the home we had put the second mortgage on. We were paying 11% interest on the funds but we were easily making a 20% or higher return on the funds so it was a good use of the cash for us.
3. JV Partner – We used a combination of private money, RRSP mortgage and a JV Partner to make the 70′s house renovation happen. There are so many options for utilizing a partner for a project like this it could be an entire article on it’s own. A JV Partner could be a carpenter or a skilled trade and put in their labour in exchange for a share of the deal. They could put in a big chunk of cash to fund the renovation and the down payment or just the renovation. There are so many options, it’s really just up to you to come up with something that works for you and gets your partner a great return.
Generally we end up using a combination of options but no matter what way we tackle it, we find the best way to tackle a renovation is to buy the property without the bank to begin with, get the work done, and then refinance it afterwards at the new improved value.
There’s certainly risk involved with this because your renovation might cost more than the value you add. The market could go down in the time it takes you to complete the renovation and cause your valuation to be lower than you expect. Or, you could run into some challenges in the renovation that require more money to get through.
If you’re thinking of tackling a large renovation like the addition of a legal suite or a total makeover of a property:
- Make sure you have your bases covered and you have options for cash if you need them. Things can come up and you don’t want this to be the project that sinks you financially because you couldn’t afford the $10,000 surprise.
- Get a good grasp of the market area before you tackle a project like this. Know the rent rates. Check out what else is for sale and what has sold in the last six months. Figure out the tenant profile (learn what is going to be important to them in this home so you can plan for that in your renovation). Using this information run your numbers. Make sure the money you’re putting in will add value (for example, generally a $7,000 roof does not make the property worth $7,000 more so watch things like this! Just because you’re putting in $40,000 doesn’t mean you can assume it will be worth $40,000 more so you have to know your comparable properties). Ensure your monthly carrying costs once it’s all complete will easily be covered by the rent you’ll bring in.
- Based on the work you need to do to attract great tenants (and make it legal if you’re going that route), make a conservative budget that include your carrying costs AND the renovation costs so you know you can cover taxes, water, sewer, hydro and any financing you have in place initially. Make sure you’re going to be ok if the project takes longer than you expect. We generally add a 10% contingency fund on top of our estimates, plus we always stress test our numbers so that if an 8 week project turns into 16 weeks it won’t bankrupt us.
A little buffer is important but a big buffer will make a good project look like it’s not feasible. It’s a bit of a balancing act and the first time you do it, it will stretch you a bit mentally but it does get easier.
Renovations are a great way to add value, increase the rental income and attract better tenants to your property. They also can contribute to improving a community and creates jobs for the people in the area. And the good news is that the options to fund the purchase and the renovation are only limited by your own willingness to make it happen.
Your Opportunity is Here – Need Help Raising Money for Your Deals?
If raising funds to do renovations is an obstacle, or even raising funds to buy more investment properties is holding you back, now is the time to take action and learn from two investors that have been raising millions of dollars from Joint Venture Partners and Private Lenders for the past 8.5 years.
There is no better time than now to start learning and putting into action the secrets of raising funds. Our JV Workshops will help you learn the words, phrases, and actions to take your investing to the next level.
Why wait till next week, month or year to get your money-raising talents in action! Buy real estate and wait…don’t wait to buy real estate.
Details on the workshops are right here:
http://jointventurerealestate.ca/
First Image Credit: © Regissercom | Dreamstime.com
