REHABBING RENTALS: The Dirty Tenant Dance
Published On: April 3, 2017 Posted by: Jeremy Peterson
Owning income property is like running a small business. You want your incomes (rents) to exceed your expenses (mortgage, repairs, utilities, management fees) in all cases. But, because you can’t control every aspect of the universe, you also want to hedge against bad things happening. In that case, you purchase insurance (tenant security deposit). Then you tend to the duties of business and as you do that things usually work out.
However, we recently ran into a situation that illustrates one of the conundrums of property management. What do you do if you acquire an income property that has mediocre tenants in the building? On top of that, you also believe that as soon as these tenants leave, you are going to have a big repair job on your hands?
For landlords that want a great management experience with superior tenants and top market value for their property, the answer is to vacate the residence as quickly as possible and spend the money on the repairs. Good units attract good tenants at top market rents. But, most landlords don’t choose this route. For many, due to a lack of available funds, the game is about deferment. The question is about how long repairs can be delayed while still maintaining rents. The answer is: surprisingly long.
But, with this deferment, there is a trade off. As the property condition declines over time, the credit quality of the tenants moves in tandem. Riskier tenants find habitation in unkempt properties. Riskier tenants also tend to deteriorate the condition of a property faster which at a certain point can accelerate the unit’s final stop at being uninhabitable. At that point, rehab must happen in order to bring the unit back to functionality and productivity.
Let’s look at an example:
A couple years ago we took over management of a multi-unit subdivided home in Ogden. The existing basement tenant was reclusive and reportedly a dungeon master of some kind. He was paying $350/mo. for a one bedroom basement apartment. When he vacated, he left this scene for us.
The owners knew the unit was rough when they purchased the building but the nicotine-stained moisture-saturated walls were still overwhelming. While this unit was refinished probably sometime in the 1970’s it had moisture seeping into the apartment after every rain storm. The stench was unbearable.
Fortunately, we had a solution for that and we gutted the ceiling and walls that were damaged. We mitigated the water problem with properly installed gutters. Then we installed new sheetrock, water-resistant flooring, primed, and got the unit back on the market.
Along with the improvements we were able to improve the tenant quality AND increase rents. We leased the unit out for $425 to a college student at WSU. The rehab cost about $4,500 to complete. However, the rents increased $75 which equaled a 20% return on investment. So, would it have been better to rent the unit out to another cave dweller and save the rehab expense? If cash was not available, probably so. But in this scenario, the rehab paid off in a big way.
So, when trying to decide whether to rehab a unit or not, first evaluate how much your rents will increase annually by making the improvement. Then divide that by the cost of the rehab. If the ROI is 10% or greater, you should probably move forward. Yet, sometimes, even if the ROI is less than that, it is worth it in order to secure better quality tenants.