Fixer-Uppers: Wise Investment Or Money Pit?
by Courtney Ronan
Would you spend $650,000 for a beachfront home with sagging shutters, no landscaping, peeling paint, old appliances, outdated wallpaper and a generally drab exterior?
On paper, the house sounds less-than-desirable -- okay, it sounds hideous. But before you answer, consider that this potential fixer-upper is located in California just steps from the Pacific. Drab as it may be, could this home sparkle one day? With a coat of paint, some "sweat" equity, and thorough revamping inside and out could this property be an investment gem?
All homes are different, but there are certain criteria which can help you spot a fixer-upper with good potential. Here are a few basic questions to ask:
What needs to be changed?
There are some homes which are structurally sound that require only cosmetic changes -- say that worn carpet from the 1960's, the historic appliances, or that inefficient heating system which consumes more fuel than a high school.
It makes sense to inventory a home to see what can remain and what must go. A good home inspection can help you spot mechanical, structural, and system upgrades that should be made, and also provide some cost estimates.
Does the area support a new and higher price?
If you buy a home for $300,000 and add improvements worth $100,000 are you ahead if area homes only sell for $350,000? What about $400,000? You need to recover the value of your investment, your time, and the cost of improvements. Many who specialize in fix-up work won't touch a project unless they can get a 100 percent mark-up -- two dollars in new value for each dollar invested.
What about the land?
In some close-in areas a home may simply not be worth an up-grade, instead it's the land and location which have value. In this case, the question is not whether to improve, it's whether to tear down. Essentially, the property's purchase price is equal to the combination of what you pay to buy it plus the expense of removing the old house. The addition of a new house is extra.
Who will do the work?
The economics of fixing-up vary enormously depending whether you're considering a do-it-yourself project or reconstruction contracted out to professionals. For the lowest cost and highest quality, it often makes sense to do both -- do much of the work yourself and then call in professionals for specialized work such as wiring, gas, and roofing.
Do You Need Repairs Or Remodeling?
According to Addie Mae, a mortgage lender, those contemplating the purchase of a fixer-upper should consider first whether the home "is in need of repair, remodeling, or both. Many homes need both types, but both don't provide equal returns on your investment."
Repair work, according to Addie Mae, usually falls under the "out of sight, out of mind" category and includes such major projects as plumbing, electrical systems and foundation repair. Remodeling, though labor-intensive, involves aesthetic projects such as kitchen updates, installing tile or wood floors, painting bathroom cabinets, etc.
"The important thing to remember is repair work usually costs money, while remodeling makes money," Addie Mae advises. "You may find a home needing $25,000 in repair costs may only be priced $15,000 below current market value. On the flip side of that, a home in need of a little cosmetic painting may be $10,000 below market value.
"One way to turn that equation around is to make your repairs into a remodel," the lender advises. "For example, if you need to replace a large amount of dry rot in a wall, try adding a picture or bay window. If you need to replace the roof anyway add skylights. If you have sheetrock damage as well you might consider vaulting the ceiling or adding recessed lighting. These simple things can turn what would normally be a money drain into a money maker."
How Much Time Do You Have?
The general rule for fixing up is that everything takes longer than planned. If you need to re-sell quickly, then fixing-up becomes increasingly risky. If you have more time available, getting the job done becomes more plausible.
How Will You Pay For Your Fixer-Upper?
A fixer-upper requires two forms of financing: acquisition money to buy the home and additional dollars to do the actual repairs and improvements. In the best case, you want one loan to provide both forms of financing so that you do not have to pay for a second closing. Some mortgages to consider include the FHA 203(k) program, Fannie Mae's HomeStyle loans, Freddie Mac's HomeWorks financing, and similar programs. If you now live in a home and need money for improvements, consider HUD's Title 1 program for loans up to $25,000,
Be aware that for financing purposes it makes a big difference whether you are an owner-occupant or an investor not living on the property. For details, speak with brokers and lenders.
Courtney Ronan is a freelance writer who contributes a weekly column profiling various communities. She also writes a weekly review of real estate related web sites. Courtney's career in journalism has included recent stints as managing editor of Agent News and as associate editor of Texas Business magazine.