Making Renovation Numbers Work for Urban Rehabs

Home Builder with New City Construction

We have been working with a home-buyer this week who wants to purchase a shell in Baltimore City, so we can then do a full-gut rehab on the property for her.  This client has had a couple of target properties in mind. Since we have done over a hundred of these projects in Baltimore, we have been guiding her about the economics and the pros and cons.

One of the things we have been talking about is what kind of properties "work" for full-gut rehabs.  Many do not. In order for a house to be a good candidate for a full-gut:

  • It has to be in a neighborhood that warrants the investment (based on desirability and appraisal)
  • It has to be the "right" size -- not too big and not too small
Another thing that we have noticed is that larger houses are only worth more to a point - mostly when the additional size increases the number of bedrooms and bathrooms.  After that, they just don't increase value by that much. So while a big 3 BR, 2BA may cost much more to rehab than a little one, it may not be worth much more.  Selling price per square foot seems to come down with house size.

Generally speaking, the construction cost per square foot for a house also goes down with size. So an 800 square foot house might cost $150/ sf, while a 3,000 sf house costs $110/sf to renovate (just rough numbers as an example). This is typically because general living space (bedrooms, family rooms, etc.) costs less than the special spaces such as kitchens and baths.  But the TOTAL construction cost goes way up for bigger properties -- in this case $120,000 for the smaller house and $330,000 for the bigger one.  Is the bigger house really worth $210,000 more than the little house?  Usually not. 

Within a metro area, construction costs are pretty much the same regardless of whether a neighborhood is good or bad, cheap or expensive. So, if the the average selling price per square foot of a community is LESS than the average construction price per square foot for a full gut rehab, then there is no way to make a full gut rehab worthwhile -- even if someone were to get a property for free! The construction alone would cost more than the finished house is worth.

What does all this mean?  When checking out a house as a potential rehab:
  1. Make sure there are other finished rehabs in the community that are selling at "market" rates.  Be sure to understand what the finished value of your house will be.
  2. Figure out what it will cost you to buy and rehab a property, and make sure it is well under the after repair value.  Remember, you have to pay for financing and other costs during the construction.
  3. Try and focus on medium-sized properties.  Our experience is that houses between 1,000 and 2,000 square feet work best for full-gut rehabs (except in very high-priced neighborhoods, where houses of almost any size can work financially).  Little houses are hard to live in and expensive on a square-footage basis.  Big houses often cost more to rehab then they are worth in the end.
If you need help with your rehab or other remodeling project, please let us know.

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