Many investors who are new to house flipping worry about overspending on their renovations. With that in mind, we've created a guide on how to keep from overimproving property. Read on below to learn what it means to overimprove a house flip, how overimproving can impact your profits, and how to ensure your renovation stays on or under budget.
What does it mean to overimprove property?
When house flipping, overimproving property occurs when a real estate investor does a renovation to the property that costs more than what it adds to the home's value in the current market. From another perspective, it also happens whenever a particular improvement is so large or so costly that the total cost of the improvement cannot be recouped when selling the home.
For investors, overimproving a property is something to avoid at all costs. Since, in this case, your main goal is to make money on the sale of the house, you should try to keep your rehab costs reasonable so you know you'll be able to cover them with your asking price. In fact, ideally, your rehab costs combined with your purchase price for the property will be much lower than the eventual sale price since you'll be able to keep any amount above those costs as profit.
Tips to avoid overimproving your next investment property
Here are a few things to keep in mind before getting started on your next house-flipping project to ensure you stay under budget and are able to make a profit on the property.
Ask a real estate agent to pull up comparables before you start renovating
In real estate, comparables are recent sales of similar homes in the same area as the investment property that you eventually plan to sell. Normally, they're used by an appraiser in order to help decide on the fair market value of the home. However, in this case, they can also be used to help you determine how much value you can add to the home before you risk overimproving the property.
For example, if you bought the home for $200,000 and all the nearby homes on the market that have recently been remodeled are selling for $275,000, you'll know that you'll have $75,000 to invest in rehabbing the house before you risk overimproving.
Focus on choosing renovations that add value
Once you have your total renovation budget in mind, stick to spending your money on the improvements and projects that will ultimately add the most value to the home. In general, it's hard to go wrong when renovating the kitchen or the bathroom. However, according to the 2020 Cost vs. Value Report, replacing old siding and deck additions are also projects that will bring you a lot of value in comparison to the out-of-pocket cost.
Keep in mind, too, that doing a renovation doesn't necessarily mean remodeling from the ground up. In fact, often, simply replacing worn-out kitchen counters with new granite countertops or replacing old vinyl flooring with hardwood floors can be just as intriguing to a potential buyer as a full-scale kitchen remodel. To that end, a big part of real estate investing is learning to spend your money where it will have the biggest impact.
Make design choices that will appeal to the masses
A key part of avoiding overspending on home improvements is remembering to make design choices that will appeal to the vast majority of prospective buyers. Put simply, if an investment property's design is too tailored to one specific aesthetic taste, it can take longer to find a buyer for the property. Whereas if you invest in finishes that appeal to the masses, you'll probably have a larger pool of prospective buyers to choose from, which makes you more likely to receive an offer quickly.
The bottom line
At the end of the day, stopping yourself from overimproving your next investment property is all about having a clear idea of what your renovation budget is and sticking to it. If you use comparables to set a reasonable asking price for the property before you even get started renovating, and you make sure you don't add to the home's value in excess of that price, you should be able to walk away from the sale of the home with a profit in hand.