The Pros and Cons of Buying a Fixer-Upper: What You Need to Know

Fixer-uppers can be attractive for two main reasons. For investors, they offer a chance to buy low, renovate, and potentially sell at a profit without a hefty initial investment. For homebuyers, they can be a budget-friendly way to break into desirable neighborhoods where move-in-ready homes are financially out of reach. In both cases, these properties require vision, as their current condition often masks their future potential.

In either case, a fixer-upper property could be the solution. While there can be benefits to buying and renovating, it's important to understand what you're undertaking if you decide to go the fixer-upper route. 

Defining the Fixer-Upper

A "fixer-upper" property requires renovation to bring it up to an improved standard and higher market value for a property of a similar size, type, and location. Such improvements can range from a simple exterior paint job to a new roof to a complete overhaul in which the property is torn down to the struts and rebuilt.

Whether you should buy a "fixer-upper" depends on many factors. One of the most important is having the patience to work with problems and the resources to solve them. Another is if you have the time and willingness to commit to the process. Finally, you should have a good grasp of the pros and cons of a fixer-upper property.

Pros of a Fixer-Upper Investment

With the right capital, experts, time, and perseverance, a fixer-upper can provide the following benefits:

• Excellent Profit Potential: If you time things right, you can often buy a fixer-upper for a low price, make the renovations, and re-sell the property for a profit. If the property is being used for investment purposes, you could also deduct the renovation expenses against the sales proceeds, potentially paying less tax on the capital gains.
  
  
• Less Competition: In some cases, fewer people might be interested in fixer-uppers, especially if they've been on the market for quite some time. This can open the door to bargains. Keep in mind that a bargain is more than price. It could also mean a low price with a modest required renovation (cosmetic, rather than structural). A good rule of thumb is to never pay more for a property than the purchase price plus renovation and carrying costs. Ideally, these expenses should be at least 25% below market value (with the 25% representing your profit). 
  
  
• Refinance Opportunity: Older properties brought back to "like-new" standards may command a significantly higher appraisal and create an opportunity for refinancing at a higher valuation. Depending on the refinance structure you choose (and the valuation increase), you could have access to more equity and take cash out.
  
  
• Tax Benefits: As mentioned above, there could be tax advantages involved with renovating a fixer-upper, especially when it's used as an investment. Additionally, you may receive a tax benefit if you can pull cash out of the deal through refinancing. Refinance loans are considered borrowed funds rather than income. When it comes to anything that is tax-related, be sure to work with a qualified tax accountant and tax advisor.
  
  

Cons of a Fixer-Upper Investment

If you wish to understand the dark side of a fixer-upper property investment, watch Money Pit, the classic Steven Spielberg-produced film starring Tom Hanks and Shelley Long and directed by Richard Benjamin. The movie is hilarious, as the couple finds continued problems with the run-down house they bought and are attempting to repair. However, the situation is not so funny in real life when hidden problems require costly repairs in a fixer-upper you might have recently bought. 

Here are some common problems when working with such a property:

• Cost Overruns: Unexpected problems you find once you close on the property could lead to unexpected expenses that go beyond your budget. In this situation, you have little recourse. To mitigate this risk, pay for exhaustive inspections before buying the property. Hire experienced, licensed building inspectors and work with an experienced building contractor unless you are one and plan on doing the work yourself. If possible, get multiple renovation quotes before making an offer to purchase any property.
  
  
• Carrying Costs: Carrying costs occur while you hold the property and renovate it. These expenses include utilities, taxes, insurance, loan payments, and interest expenses. Carrying costs can be substantial if the renovation takes longer than expected and/or the renovated property stays on the market for a longer-than-anticipated period.
  
  
• Real Estate Valuation Decreases: The real estate market is subject to widespread market downturns and serious unexpected property devaluations. Suppose you plan to renovate a property in a particular location to improve valuation. Then, while the property is under renovation, general economic conditions change and all properties in the area decrease in value. Your property could be impacted, despite the upgrades and renovations. While the situation is outside of your control, a downturn could make your property unprofitable, causing you to lose money.

Finding the Right Fixer-Upper

To find the perfect fixer-upper for your next project, consider using PropertyReach's powerful tools. Their platform is ideal for discovering off-market properties with great potential, allowing you to create custom search criteria and uncover hidden gems perfect for value-add investments or fix-and-flip opportunities. You can learn more about Property Reach through a seven-day free trial. 

Some important screening parameters include the following:

• Motivated Sellers: Look for properties with potentially motivated sellers: Seek out situations where owners might be willing to sell below market value. This could include properties facing foreclosure, those owned by out-of-state landlords, homes part of estate sales, or properties with delinquent taxes. Owners dealing with divorce, job relocation, or financial distress may also be more open to quick, below-market sales.
  
  
• Age and Condition of the Property: Seasoned real estate investors who work with fixer-uppers mainly consider properties that need cosmetic renovations but are structurally sound. In industry language, these are properties with “good bones.” A structurally sound property means you don't have to gut the property to the foundation and then rebuild it. A structurally sound property can be less costly to renovate, and there is less potential for serious issues like dry rot or pest infestations.
  
  
• Property Comparisons:  In real estate investing, property valuations are determined by "comps," which are comparable properties of the same size, the same number of bedrooms and bathrooms, and located in an equivalent neighborhood. Also, you want to determine if other properties in the neighborhood are owned/occupied or not. Owner-occupied properties are usually kept in better condition than rental properties due to pride of ownership.
  
  
• Location: The most important attribute in real estate is location. You want a property near employment, shopping, and good schools. Another consideration might be whether a property is near public transportation.
  
  
• Amount of Deferred Maintenance: Deferred maintenance are things that should have been done to keep the property in good condition but weren't done. Too much deferred maintenance could increase the cost of your repairs, requiring more money to improve value.
  
  

Issues to Consider with a Fixer-Upper Investment

There are key metrics and factors to analyze for any investment you make, let alone fixer-upper properties. Here's what to think about when considering a value-add property purchase:

• Required Capital Investment: The total capital needed includes the purchase price, the renovation costs, and the carrying costs. You also need to set aside a contingency fund of at least 10% of the total deal value in case you find hidden problems or come across unexpected expenses.
  
  
• Planned Holding Period: Your best-case scenario involves how long you'd like to hold the property. More often than not, you'll end up with a likely-case scenario, which includes factors that extend your hold period, like labor availability, materials costs and market conditions when it comes time to sell. Then there's the worst-case scenario, which can significantly extend your timeline. It's always best to plan your hold strategy around the worst-case scenario.
  
  
• Property Value Strategies: Ensure your renovation plan focuses on the items that increase the property value. At the very least, Better Homes and Gardens recommends refreshing the property with new paint, inside and outside, using complementary and neutral colors. Install new flooring, upgrade the exterior, remodel the kitchen, replace windows and doors, and repair drywall and ceilings. Also, remodeling the bathrooms is recommended. Other means of property improvements include replacing appliances and HVAC systems and upgraded exterior landscaping. Any improvements you make should cost less than half the value of the anticipated property value increase. For example, a budgeted $20,000 kitchen remodel should increase the property value by a minimum of $40,000.
  
  
• Proper Staging: When you're ready to sell the improved property, be sure to stage it. Staging relies on interior design techniques and rental furniture to make the property more homelike. When done correctly, staging can help you earn the highest possible value on the sale of your property.

Next Steps

Investing in a fixer-upper isn't for everyone. It requires vision, resources, and commitment. While some may see a run-down property and think, "What a dump!", others see it and exclaim, "What an opportunity!" Your perspective and goals will determine whether a fixer-upper is right for you.

If you're looking for a fixer-upper to meet your investment or residential goals, tap into PropertyReach's extensive database that supplies plenty of information on your properties of choice. To learn more, log onto propertyreach.com and find the fixer-upper -- or any other property -- to meet your specific requirements.