The Art of Selling: How McDonald’s sold me a dream twice and I had to go to Disneyland to learn to dream again? I was watching a movie on a plane ride which was about a woman who was
Buying a Fixer Upper vs. a Fully Renovated House
Dated: April 15 2021
Buyers are often plagued with many choices. Is it better to purchase a house for a lower price that needs a complete renovation or buy a move-in-ready house? Let’s go over the options. A fixer-upper is a frequently dated property that needs a complete upgrade before moving in. A renovated house is already move-in ready where you won’t have to invest money and time to repair.
Let’s start with a fixer-upper. The general consensus is that a fixer-upper can save the buyer money since they are purchasing it at a lower price. This popularized assumption is presumptuous. When examining sales data, we can see that purchasing a fixer-upper requires a huge sum of funds upfront. You would need to purchase the property with limited to no financing in order to participate for a more competitive price. The first provision is that you need adequate capital. A fixer-upper sell at a discounted price simply because they don’t have the option to sell to the mass market. Buyers who are using more favorable financing options like Conforming, FHA, VA, and Jumbo loans need to face stringent guidelines. The lending institution for FHA and VA loans will require a property to be in pristine condition before approving a loan for the market value. You would also need to past appraisal for Conforming and Jumbo Loans. The appraiser will need the home to be functional which will eliminate some fixer-upper options. In reality, the competition is fierce when it comes to bidding for a lower-priced property, so the terms have to be attractive. You are competing against handyman, contractors, and investors who all have advantages in capital, resources, and experience. They won’t need to do an inspection because they are the inspector most of the time, they won’t need financing, they can afford greater risk since they are in the business. As a first-time homebuyer, this option more often than not is out. Even if you do have the funds, you may not have the experience to waive your inspection option.
When would it be proper to purchase a fixer-upper? Well, let say you have experience already as a purchaser. This is not your first home. Another common scenario would be you have a trusted comrade who has the experience to guide you through the process and you also have the funds. Then the analysis will be numerical thereafter. How much will you be able to purchase the property for to make it an attractive option vs buying a fully renovated property? Here are the factors to include. The cost of renovation, the holding period between renovation, and the total cost of the purchase. Most of the time, the cost of renovation will deem you noncompetitive since contractors have the inherited advantage of not having to pay labor costs for construction work. The most expensive part of renovation is the labor cost which in major cities like NYC can range 50-60 percent of the entire renovation depending on the job. If the job costs $100,000 for you to hire a contractor, then it only costs $50,000 or less for a contractor. You are already at a renovation cost disadvantage. Second factor, the holding period. How long will the renovation take? Unless you are the contractor yourself, this is out of your control. Your estimated time is contingent on other people’s opinions. This is relevant since you have taxes, insurance, utilities, and even a mortgage to pay during the renovation period. Major renovations take on an average of 3-6 months. This cost has to be deducted from the offer price in order for it to be sensible. Contractors who are doing the work themselves can shave a month or two off depending on how hard they want to work. You don’t have that option. If there is a mortgage, then the expense will be greater, and this option is even less attractive. The last would be the cost of the purchase, how much is your closing cost. The deciding factor here would be if you are getting a mortgage. The biggest expense with all being equal is the cost to secure a loan. You are automatically 2 percent less competitive if you are getting a mortgage since the cost of a loan is typically 2-3 percent/ thousands of dollars.
A scaled-up investor has an advantage in renovation since they or doing the work themselves. The difference is already a 50 percent in renovation cost advantage. They won’t need financing since they are in the business and already have access to low-cost capital. That is another 2-3 percent advantage off of selling price. They sometimes do not need a loan to close on the property since they may have internal professionals to run title and due diligence. A real-life example will look like this. The median house price is $300,000. The cost to renovate the property cost $100,000. The cost of a mortgage is $6,000. The monthly expense to hold the property is $1,000 (with a mortgage) and the time it takes to renovate is 6 months. Holding cost would be $6,000 ($1,000 per month x 6 months). The total cost for the investor is $53,000. He can do the work himself and cut the labor cost, he doesn’t have a mortgage and can get the work done in 3 months since he has control over the work schedule. The highest price the investor can bid to still be competitive would be $247,000 ($300,000 market price- $53,000 renovation plus purchase cost). The average buyer’s cost would be $112,000 (Sum of $100,000 renovation, $6,000 mortgage cost, $6,000 holding period). The highest price you can pay is $188,000. From a numerical point of view, the average buyer is non-competitive.
Does it make sense even if you have the same advantages as the investor? In reality, the situation of renovation is much worse since you are not doing the work. There are hiccups during the renovation that can cost you more. Not to mention the intangible cost of time and stress invested. The opportunity cost of lost production since you have other full-time work and responsibility. The work is arduous and requires assiduous care for a rudimentary turnout.
The renovated house is the solution for all of these issues. It does come at a cost since the most renovated house is provided by investors mentioned in the examples above. Let say they are in the for-profit business to earn a 10 percent return on investment. That means the renovated house would cost $330,000 ($300,000 median-priced home plus $30,000 profit.) That would mean you are paying $30,000 extra for someone to do the work for you. Most of the time that would be the only option available for a first-time buyer with limited funds. The dilemma occurs when a buyer has extra funds available. The tradeoff is worth it since you will be getting a house that move-in ready and won’t have to experience the strenuous 6 months renovation process given in the examples above. The mortgage will be paid over the course of 15 to 30 years.
The common argument to purchase a fixer-upper despite knowing the cost disadvantage is to fix the house to your preference. This misconception has been over-glorified. To start, the human being is an insatiable creature. Even if you build a home from scratch, it won’t fit 100 percent to your liking. You will be lucky if it meets 90 percent satisfaction. The additional cost is a luxury. Unless you have unlimited funds, the topic is out of the discussion. Even if you do have the funds, it may not be a financially savvy decision. In order for the work to justify the cost, you would need to live out 50-70 percent of its life expectancy. This would mean that you would need to live there for at least 10-15 years. There are unpredictable life occurrences that would encumber you from living the entire life expectance of your renovation. For you to maximize the worth of the preferential luxury would take you a minimum of 10 years. Within that 10 years life changes such as employment, marriage, family, life aspiration, health would have to be planned a predictable for you to be confident enough for it not to elude you from fulling the 10 years of enjoyment. Any one of those common life changes will obliterate your entire investment.
The median house is copious in all of its variations. The selections are abundant. Comprising for $300,000 would be more economical as compared to purchasing a renovated property of $330,000. Aligning your goal with reality would be the sagacious way towards living a financially savvy and fulfilled life that would be flexible towards the only constant, change.
Each situation is different, understanding the intricacy of the options available will guide you towards better decision making. Be scrupulous and please enjoy!
Peter began his career at a small real estate brokerage in 2009, during one of the most difficult markets in decades. While many other agents left the business, Peter decided he was going to persevere....