There are countless ways to make money in real estate, all which require skill, foresight and preparation. A renovation is no different. Whether your project is a “buy-fix and sell”, repairing a rental unit or improving your principal residence, there are a few things to consider.
First, you must ask yourself whether injecting any money into the property will actually increase its value. To answer this, you need to understand your market. This requires becoming an expert on property values in your neighbourhood through sales comparables. You must know:
Let’s use an example to illustrate this point. House number one is $350,000 and the house size is 1400 square feet. Divide 1400 into $350,000, you get $250 per square foot. A similar house in the same neighbourhood is $450,000 and 2800 square feet with a separate entrance and an unfinished basement. This one works out to $160 per square foot making it obvious which is the better deal.
We look for properties that are easily “suite-able” where the second unit allows us to buy below the average square foot price. Although one comparable is not enough, you can see how this is easier to compare properties that are not exactly the same.
A third example could be a $600,000, 2500 square foot property, renovated with a finished basement and separate entrance. This works out to $240 per square foot. Clearly we can see that the second example of $160 per square foot allows us understand there is an $80 per square foot spread in which we can potentially profit.
This knowledge allows you understand your projected cash on cash return (how much cash or equity value every dollar you spend puts back in your pocket) and whether even considering the project will be worth it. As a side note, I always recommend doing repairs on rental units in order to keep happy tenants, but tackling a fix and flip or renovating your home for profit must be considered carefully prior to commencement.
If the numbers look good and you decide to move forward, the next step is creating a specific “game plan” for the renovation. Understanding exactly what to fix and what not to fix will give you the biggest “bang for the buck.” Typically the kitchen and main bathroom, including sinks, countertops, fixtures and flooring will provide the most upside. Painting the entire house with a neutral colour provides a “flow” to the house and paint is more affordable when you buy a large quantity of the same colour.
Landscaping is another area which is relatively inexpensive, yet adds a lot of value and “curb appeal.” The property may also require larger improvements such as windows, roof or furnace replacements, however it is often difficult to justify these amounts of renovation dollars unless your calculations still allow a profit.
To gain perspective on properties in your area, it is important to check out other houses in the neighbourhood and understand to what degree people are renovating. This is easily accomplished by visiting open houses. Never make the mistake of renovating to a standard that is higher than that of the neighbourhood.
If the “fix and flip” model is a little too daunting, a very affordable, slow and steady strategy is to renovate your principal residence for profit. Once the renovation is complete, you have presumably increased the value. The next step is to refinance the property and use the capital to purchase another property and repeat the process. This is a great way to begin building a portfolio. Remember, you can continue to purchase with as little as 5% down, move in, renovate and repeat. Make sure you are buying properties that will cash flow once you move to your next which is why the secondary suite is so important in higher priced areas.
A similar strategy is to renovate your principal residence, sell the property at an increased amount, use the capital (which is non-taxable in Canada) to purchase a more expensive property. By repeating this process, many people ultimately wind up in their dream home, often with a fair amount of equity.
You may simply want to renovate your home to make it more energy efficient or accommodate a growing family or just bring a new look to the house. Either way, strategic renovation comes into play.
As a side note, there are many government grants and rebates available for a number of these renovations that will add to your savings on your renovations.
Before you jump into buying supplies and hiring contractors, ask yourself the proverbial question…how are you going to pay for this renovation?
The first thing to do, whether you are paying with your own cash or intending to get a loan, talk to a financing specialist such as myself, who can help you understand your options and pre-approve you for a specific amount of money needed for your renovation, fix and flip or your next purchase. Let’s look at some of the options to consider.
Cash
If you have saved adequately, use your own funds. Make sure the cash outlay won’t overly affect your ability to qualify for your next property or affect your cash flow. When choosing to cash in an investment such as a stock or mutual fund to do the renovation, measure the loss amount it could be making in interest and include any early redemption fees versus the amount of interest paid on the renovation loan.
Credit Cards
The convenience of plastic allows the renovation to begin immediately rather than waiting for a loan approval. Remember to pay them off quickly or be faced with high interest rates. Be careful not to carry a high balance relative to your limit as this can significantly affect your credit score.
Credit cards from one of the big box stores can be an option. Some of these stores have been known to offer zero interest charges for 6 months. Again, consider your ability to pay off the card quickly as well as the credit bureau “hit” when considering any credit card.
Unsecured Personal Line of Credit
An unsecured personal line of credit (PLC) could be just the thing to pay the renovation costs. Banks give an unsecured personal line of credit based on a favorable credit bureau, confirmable income and an amicable history with the bank. These vehicles allow the borrower to pay off as much as desired at any time. They are available in fixed rates but are more commonly offered with variable rates.
Secured Line of Credit
A secured line of credit, commonly known as a home equity line of credit or HELOC is a lower interest way (compared to the PLC) which lets a homeowner use the equity in their home to borrow money, where the home is used as security. This allows payments that can be as low as interest only. You can pay as much as you want above the minimum required payment.
You can access up to 80% of the appraised value (or purchase price) of the home and as you pay down the outstanding balance, the available credit increases. Most lenders will allow a conversion into a lower fixed rate mortgage.
Bank Loan
A bank loan is perhaps the simplest way of financing your renovation. Payments on the loan will be withdrawn at regular intervals from your bank account to repay the loan. Just like a mortgage, if you can pay down the principal faster, you pay less interest. Therefore arrange your payments for a bi-weekly or weekly payments.
Refinancing Your Mortgage
When you refinance a mortgage, use the existing equity in your house to increase the mortgage amount up to 80% (or more based on the lender and insurer’s approval) of the home’s appraised value. This enables the mortgage payments to be spread over a longer period of time which take advantage of lower mortgage rates, ultimately resulting in lower payments than a PLC or HELOC.
There are costs involved which may include appraisal fees, legal fees and possibly a penalty for breaking the mortgage. Crunch the numbers and determine if this makes sense against other options available.
Purchase Plus Improvements
This owner occupied program, insured by both CMHC and Genworth Financial allows the buyer to purchase a property with up to 4 units for as little as 5% down and get cash to do renovations. The amount of the mortgage is calculated on either the after repair value or the total of the purchase price plus the cost of improvements…whichever is less. The mortgage options of either fixed or variable are available and qualification is the same as in any property purchase.
Second Mortgage
Depending on the amount of equity in the property, a second mortgage for renovation can be acquired in the form of an equity based 2nd mortgage. This is typically repaid over a shorter time period than a conventional mortgage. A second mortgage can be acquired from private lenders or many “B” lenders and will be registered as a second charge behind the first mortgage.
Many second mortgages commonly have higher interest rates as well as lender, broker and lawyer fees which are often paid upfront as a deduction to the mortgage advance. Second mortgages typically have a term of one year with interest only payments, although an open 2nd mortgage is possible.
Joint Venture Partners
Joint venture partners can become money partners, mortgage qualifiers, bird dogs or fix and flip partners. Whatever level you are at, partner with someone who is involved full time in real estate that can help you gain knowledge, experience and profit.
In closing, make sure to crunch the numbers and carefully consider the amounts you will pay for these loans, mortgages, credit lines or partnerships as compared to the potential profit or equity value you expect to gain from the property, prior to deciding to move forward with any renovation.
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