Profit from cosmetic rehab sought by a REDDIT reader is a myth
Posted by John Reed on
A REDDIT real estate investing group member posted this question:
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Plan to buy a house that needs mainly cosmetic work with a FHA or conventional loan to put 3.5 - 5% down. Live in the house for 2 years while rehabbing. Then sell it avoiding any capital gains tax and use the profit and savings over two years for a 2-4 unit house hack. If market tanks then backup plan would be to rent it and buy another primary residence with savings over the two years, or just live in the house while saving money. The primary point of doin this would be I only have around 20k for investing and would like to get into the market instead of renting and not building equity.
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Reed answer: There is a 3.5% down FHA loan I have not heard of a 3.5% down conventional loan. If you put down $20,000 and that is 3.5%, your purchase price is $20,000 ÷ .035 = $571,000.
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To qualify for the $571,000 - $20,000 = $551,000 mortgage, you need enough income and a good credit.
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The idea that doing cosmetic work raises the value of the building more than the cost and the value of your labor is widespread and untrue. To do that, the house would need to be a cosmetic disaster, structurally sound, and in an excellent neighborhood. But a house or even just a lot in an excellent neighborhood, will be scooped up fast by a home buyer or home builder.
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The more common closest you would get to a house needing massive cosmetic-only work would probably be one with some deferred maintenance but mostly not needing anything desperately.
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I asked a long-term investor friend of mine is he ever made money on fix-ups. He said it only worked when he was able to add a bedroom or two without adding foundation, new exterior walls, and new roof. In other words, the additional bedroom cannot be an addition to the square footage of the house. The square footage of the house does not change; only the floor plan. One he told me about was a one-bedroom with an eat-in kitchen and a formal dining room. He eliminated the formal dining room and added a second bedroom.
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I have done similar improvements that were quite profitable. One was turning a large store room in to a second bedroom. Another was changing a large store room into a studio apartment. That works. Cosmetic improvement does not.
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And it is hard to find existing structures where you can add a second bedroom which has enough excess square footage to do that and not have any overly small rooms when you are finished.
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If it is your principal residence, and you sell it at a gain after living in it for at least two years, you can exclude $250,000 per spouse of any capital gain from taxes. IRC §121
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Do NOT do cosmetic renovation. It will cost you more in the cost of materials and your labor than it will pay in increased value. The people who claim to have done profitable cosmetic rehab actually did not thereby increase the value of the building. The building went up in value like all the others around it. If you subtract the general marketwide appreciation that happened to all buildings in that neighborhood, you will find that the cosmetic rehab was a waste of time and money. Those who disagree are claiming appreciation that happened for nothing but normal inflation on every house was the result of their rehab. In the typical case, if you investigate, you will find that the whole area went up, say, 13% during the time you were rehabbing, and your house went up 13%. The profit from your rehab? Nothing.
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Plan to buy a house that needs mainly cosmetic work with a FHA or conventional loan to put 3.5 - 5% down. Live in the house for 2 years while rehabbing. Then sell it avoiding any capital gains tax and use the profit and savings over two years for a 2-4 unit house hack. If market tanks then backup plan would be to rent it and buy another primary residence with savings over the two years, or just live in the house while saving money. The primary point of doin this would be I only have around 20k for investing and would like to get into the market instead of renting and not building equity.
.
Reed answer: There is a 3.5% down FHA loan I have not heard of a 3.5% down conventional loan. If you put down $20,000 and that is 3.5%, your purchase price is $20,000 ÷ .035 = $571,000.
.
To qualify for the $571,000 - $20,000 = $551,000 mortgage, you need enough income and a good credit.
.
The idea that doing cosmetic work raises the value of the building more than the cost and the value of your labor is widespread and untrue. To do that, the house would need to be a cosmetic disaster, structurally sound, and in an excellent neighborhood. But a house or even just a lot in an excellent neighborhood, will be scooped up fast by a home buyer or home builder.
.
The more common closest you would get to a house needing massive cosmetic-only work would probably be one with some deferred maintenance but mostly not needing anything desperately.
.
I asked a long-term investor friend of mine is he ever made money on fix-ups. He said it only worked when he was able to add a bedroom or two without adding foundation, new exterior walls, and new roof. In other words, the additional bedroom cannot be an addition to the square footage of the house. The square footage of the house does not change; only the floor plan. One he told me about was a one-bedroom with an eat-in kitchen and a formal dining room. He eliminated the formal dining room and added a second bedroom.
.
I have done similar improvements that were quite profitable. One was turning a large store room in to a second bedroom. Another was changing a large store room into a studio apartment. That works. Cosmetic improvement does not.
.
And it is hard to find existing structures where you can add a second bedroom which has enough excess square footage to do that and not have any overly small rooms when you are finished.
.
If it is your principal residence, and you sell it at a gain after living in it for at least two years, you can exclude $250,000 per spouse of any capital gain from taxes. IRC §121
.
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