There are a ton of ways to add value to your rental portfolio, but the easiest and most common way is through an interior upgrade, aka through “renovation”.
Don’t get caught up in the choice of words here. I know a lot of people aren’t looking for a big “project”. Interior upgrades shouldn’t be confused with a typical remodel on a house flip. For apartments, they are usually much faster and easier.
We’re going to get into all that but, but first, let’s catch up on some terminology.
What Does it Mean to Add Value to a Rental Property?
Any time you increase the value of a property, you’ve “added value” to it. Where people get caught up is they think the only way to add value is through significant renovations.
While this article is covering the interior upgrade, there are dozens of ways to add value to rental property.
Commercial property values are determined based on a formula of rental income and operating costs. So, anything you do that increases rents or decreases operating costs will lead to increased value.
This could be through tenant turnover, changing management, charging for laundry or covered parking, even changing contracts to reduce the cost of snow removal will add value to an apartment.
Certain things can reduce the value as well, such as having a significant amount of deferred maintenance.
What is an Interior Upgrade?
An interior upgrade can range from new floors and paint for a couple thousand, all the way through a top to bottom remodel that can be $10-$20k.
In general, it will be somewhere in the middle with floors, paint, fixtures, and sometimes counter tops. Cabinets and appliances will come in for a higher end upgrade.
Why Not Do a Full Remodel?
When you’re remodeling an apartment, you have to consider the cost of the upgrade vs the increase in rent you will get. For example:
Let’s say you are receiving $1,000 per month for an apartment in its current condition. You’ve identified that you can dull a full, top-to-bottom upgrade and increase rents by $225 to $1,225. Or, you can do a partial upgrade and receive $1,150 in rent.
In this hypothetical example, let’s say the partial upgrade is just floors, paint, light fixtures, faucets, along with new laminate counter tops totaling $3,500 because it’s a small apartment.
The full upgrade will cost $10,000 because in includes new appliances, and cabinets.
A quick ROI analysis will show:
$150/month = $1,800/year.
$1,800 / $3,500 = 51% per year return for minor upgrade
$225/month = $2,700/year
$2,700 / $10,000 = 27% return per year for the major upgrade.
As you can see, you’ll get a higher return by doing LESS work.
This is obviously a basic level analysis and doesn’t consider the increase in property value. But, you’ll generally see something similar play out in other situations.
How Upgrades Increase Value
Real estate values for rental properties are determined on one of two ways. Either through a comparative sales approach, or with an income approach. For more information about either method, click on the links for a deep-dive.
But, upgrades increase value under either method. For the comparative market approach, your property will sell for more because other properties with upgrades will have sold for more.
If we are using cap rates and Net Operating Income, then the value comes from how the upgrades increase the rents.
Example Interior Upgrade
I bought this property a couple years ago, and it’s been a cash cow for me. I’m going to go over some of the interior upgrades I did and explain it in this series of videos!
Before Starting Work
In this video you can see the tenant left a bunch of trash, floors are old and worn, and the paint is scuffed and old.
It is very common to see your apartments in this condition after a tenant leaves, especially if they lived there for a number of years. Apartments just get worn and it is totally natural.
In this example, the unit probably hadn’t been upgraded in 20+ years, except the bare minimum.
Upgrade in Progress
Final Results of Interior Upgrade
As you can see, in these mid to lower end apartments, it does NOT need to be perfect. It’s high end for the area.
We increased the rent by around $300/month which is $3,600 per year.
I estimated this added over $35,000 in value and the total cost was around $7,000 if I remember correctly. It was expensive because this apartment is quite large and there was a lot of floor area to cover with new flooring.
Creating an Interior Upgrade Program
As the name suggests, an interior upgrade program is a systematized way to upgrade your units rather than doing it in a haphazard way. How you go about this will depend on:
- Your budget
- The timeline
- Your crew
Budgeting For Upgrades
There are a few different ways to go about this. The first, and most obvious, is to simple set aside up front enough cash for the entire project.
If you have 10 units to upgrade at $5,000 each, then take $50k (plus some contingency) and set it aside before getting started.
This can be difficult if the projects are very expensive, or you have a lot of units to upgrade. So, you can alternatively determine how much you can set aside monthly/quarterly to budget for rehab.
If you can set aside $7,500 / month from your cash flow, then you can do 3 units every 2 months (assuming $5,000/unit upgrade cost in our example), or 18 units per year. Then, you can simply back into how long it will take you to do all your units.
Upgrades Based on a Timeline
Another way to plan your upgrades is based on a timeline. You might want to refinance or sell the property in 12 months, so you want to have a certain number of upgrades done by then.
Then it’s just simple math to figure out how many turnovers you need to do each month.
Let’s say you have 10 units and want them all upgraded within 12 months, then we know you need to do 1.2 upgrades per month, or 6 units in 5 months.
Based on the $5,000 upgrade cost we’ve been using in the previous example, you would need to budget a minimum of $6,000 per month in upgrades.
Additionally, you can start planning out and giving notices to your tenants based on your timeline to get them to move.
Upgrade Timeline Based on Your Crew
During hot economic times, good crews are expensive and hard to come by. Even if you had the budget to do all 10 units this month, you might not have the crews available to get that much work done so quickly.
It might not matter what your timeline is or how much cash you have available, if you can’t find crews to do the work, you’re stuck on their timeline.
Keep this in mind when you’re planning and budgeting your upgrades.
Interior Upgrades Increase Rent and Value
Interior upgrades increase rents and values, so they are a no-brainer. But, you need to consider your budget, timeline, and crew availability.
Have you ever done an interior upgrade? What were the results? Did you earn more from rent? Comment Below