If you are considering buying a fixer-upper property and renovating it, it is important to understand all the upfront costs.
This article mainly addresses large-scale, gut renovation projects of an entire property. It is not applicable for smaller renovation projects like kitchen remodels or bathroom remodels.
If you are considering a multi-unit investment property, analyze the numbers for the annual cash flow of the building once it is operational. A separate article on these numbers is here.
I’ve broken down the costs into four main categories. Jump ahead to a section below:
Acquisition Costs
Acquisition costs are the expenses associated with buying the property, they include:
The purchase price of the property
Closing costs to purchase the property- In Chicago closing costs are typically 3% of the purchase price. Your lender and real estate agent should be able to help you with estimating this expense. Note that some renovation loans have two separate closings. If that is the case for your loan, add the cost of the second closing as well.
Construction Costs
The costs for the renovation itself include:
Architectural Fees-The architect you plan to use should be able to provide a rough budget for this number.
Permit Fees- The architect can also help estimate city and permit costs. The architect is typically the one that files for the permits.
Actual Construction Cost- Contractors should be able to provide a rough range of a price per square foot for your project before they have full architectural plans, etc. If you plan to use a renovation loan, the bank will likely require plans and a full contractor budget to proceed with the loan. Add at least 10% to whatever a contractor quotes you to account for surprises and changes!
Any items not included in the contractor’s quoted construction cost- Landscaping, appliances, and security cameras are examples of items often not included in the contractor’s budget. Ask the contractor which items are not included in the estimate so you know to add them to the overall budget.
Carrying Costs
Carrying costs are the expenses that are occurred while you own the building, but while it is vacant during the renovation period.
These costs include the items listed below. To calculate each item, take the number of months that the contractor says the job will take, and prorate each number accordingly. I recommend adding 60 days on top of whatever the contractor quotes. Be sure to account for the time working on architectural plans and waiting on permits in addition to the actual renovation period.
Taxes-If the building is vacant, you may be able to file a tax appeal to lower your taxes during the renovation period.
Gas-Assuming the building will be vacant, you will be responsible for maintaining reasonable temperature levels for the contractors. You also need to maintain adequate temperatures for the proper installation of hardwood floors, trim, windows, etc.
Snow removal-During the renovation, owners are only required to clear the front public sidewalk. This is usually less expensive than clearing all walkways and stairs on the property.
Landscaping- This expense should be minimal, but you should mow any lawn area to avoid violating local codes or ordinances regarding overgrown lawns.
Insurance-For a significant renovation project with a vacant building, a different type of insurance will be needed during the project. For a small building, assume it will be roughly $500 higher than the regular annual insurance cost.
Interest/Mortgage Payments- If you bought the property for cash and use cash for the renovation, there won’t be an interest or mortgage expense here. If you are using a rehab loan, then you will likely only pay interest (not principal) during the time of the renovation. If you bought the property with a traditional mortgage and are paying cash for the renovation, then you should account for the monthly cost of your mortgage as a carrying cost.
Trash- If your contractor plans to use a dumpster, there shouldn’t be a need for additional trash service. Confirm with your contractor the plan for construction debris removal.
Electric- The renovation project will require electricity for lighting and tools. This electric expense is typically significantly less than what it would be for an occupied property. I would estimate this expense as 30% of the cost if it was occupied.
Water- Account for water usage during the project (flushing toilets, cleaning tools, etc.). This number will be significantly less than an occupied property.
Carrying Costs of an Investment Property
If you are buying a property that is currently a multi-unit property with renters there are additional costs to consider.
Tenant buy-out costs- If the property is purchased with existing leases and tenants, you may want to consider negotiating a deal with the tenants for them to move out quicker. I do not recommend a large-scale renovation while tenants occupy any part of the property. There will be electric and water outages, noise, dust, etc. Tenants are usually not very tolerant of any of the above items. In Chicago, tenants have the right to stay until the end of their lease. If you prefer for them to move on, they have to agree to it by choice. Often owners will offer a sum of money for them to move out. If a tenant accepts this type of deal, then this is an additional cost you should account for.
Operation Costs Before the Start of Construction- Once you purchase a property with tenant occupants, you will collect rent from the tenants and incur all the expenses associated with operating the building, common electric, water, landscaping, snow removal, etc. The rents may cover all of the expenses, or they may not. If the rent covers more than the expenses, you may make income during this period. If the rent doesn’t cover all of the expenses, this is another renovation cost that should be accounted for. Often a small building will sell with one occupied unit and one or two vacant units. You won’t be able to start the project until all units are vacant but need to operate the building until the final set of tenants moves out. To learn how to calculate these income and expense items, refer to this article.
Acquisition costs + construction costs + carrying costs = total building cost
These numbers should establish how much cash you will need for the project and whether or not to consider financing for the renovation.
Ideally, the total building cost should be less than or equal to the post-renovation market value of the property. Have your real estate agent research comparable properties to determine the post-renovation value.