One of the most common questions I get from new real estate investors is: How do you know how much it will cost to renovate a property to either flip, rent, or for their own home?
Learning how to wrap your head around a construction project and come up with an accurate budget is a critical skill in value add real estate investing and a cornerstone in successfully pulling off forced appreciation. The best way I know how to do this is to look at the big picture and then systematically break it down into all the required components. Once I get a list of all the components of the job required, I get bids on the work or estimate using per-unit costs.
When I first started, I used to think I could walk a house and think well. This is a cosmetic rehab on a 2 bedroom 1000sqft house; it will likely be 30k. This is not the case, though. The scope of work required from one house to another varies based on what needs to be done and their scale.
Step 1: Walk the Jobsite
The first step is to get your bearings on the project. You will want to take photos, maybe a walkthrough video, and get measurements. On the first few projects you estimate, do not feel bad if you return to the job site to get more details and measurements.
If you do not have much experience with construction, it will be good to either walk the job site with a contractor, home inspector, or investor with lots of experience in the type of rehab you are estimating.
Step 2: Break Down the Work
I have found that the best way to do this is to work through the project linearly through time. Then, working through the construction process, write a breakdown of the basics of what you will be doing in each step.
The first step to think about is demolition what old materials will have to go away to complete the rehab you have envisioned. You might write something like “remove all carpet, cabinets, plumbing, and electric fixtures.” Then, working from demolition, you move into framing, trades, insulation, drywall, paint, finish trim, etc. Tackle each one with a short description of the work that needs to be done.
Step 2: Scope the work
So now you have a list of what you want to do in each category. Such as replacing the roof, replacing windows, replacing kitchen cabinets. At this point, it is somewhat high level. This is the point where we will start drilling down to more specific finishes and quantities.
For instance, you might have a line that says replace windows. This is the time to drill down and answer the questions about each item. What kind of windows? Vinyl replacement? Do they have a white exterior or a painted exterior? Or are you adding aluminum-clad or casement windows? Then, how many of these windows are you replacing?
For carpet, you will want to know the square footage, what pad you plan on using, and what type of carpet. Again, you can get away with not having the exact SKU in this stage, but maybe call out low-end, mid-range, high-end so long as you will know what that means to you in the estimating phase.
There are items that you can scope in multiple ways. For instance, you could say it is 8 rooms to be painted, 1500sqft of floor space, or you can calculate out the wall area. If you have drawings on the project, calculating the wall area can be more precise for estimating how many gallons of paint will be required. For most projects, this will likely be too much detail, though. As you work through a few budgets, you will start to find a middle ground of detail that works for you.
Step 3: Start Estimating
So now you should have a list of trades and what needs to be done to complete the work. For instance, you might have:
Flooring:\Remove existing carpet and install nail down pre-finished hardwood in dining room, kitchen, and living room. 600sqft\
You will need to estimate both labor and material costs for this part of the project. To estimate labor, you can start calling flooring subs and see what they charge per square foot, or you can look online for averages per square foot if you are looking to get more of a ballpark at this time.
Then to get material costs, you can search for pre-finished hardwood at a big box store and get the per square foot price. Add in a waste factor, likely 10-20%. Usually, in the scenario of nail-down flooring, the sub supplies the nails. It is worth researching all the materials required for each line of the scope of work.
The counts, square footage, linear feet, etc., used when creating the scope of work are essential in this stage.
This process will take a tremendous amount of time the first few times you go through it. However, once you start getting used to some of the costs, you will be able to re-use some work you have already done.
Step 4: Putting it all Together
Some people prefer to write the scope of work out in sentence and paragraph format. Some people prefer to keep it in a spreadsheet. Using a spreadsheet, you could add columns for labor, material, and a total estimate. If you created it in paragraph format, you need to convert it into a spreadsheet line by line first.
I mostly work in a single spreadsheet, and then on complicated line items, I link to a secondary supporting worksheet with further breakdowns and descriptions of the work.
Here is a snippet of a spreadsheet that I have used to estimate rehab costs:
This spreadsheet is pretty much a list of all the items you typically encounter in a residential remodel. I usually work through it by highlighting the areas in green that I am confident in either by getting a bid or getting precise with the specification.
Three Shortcut Techniques
Rather than going through the whole project, getting quotes, and making estimates for every aspect of the scope of work, you can use these two techniques to get ballpark estimates. They are the Cost Per Square Foot Method, Ballpark Lump Sum Method, and the Room Estimation Method.
Cost Per Square Foot Method
Using the Cost Per Square Foot method of estimating, you will take the average per sf cost for the level of renovation required (ex. full renovation, cosmetic, cosmetic plus mechanicals) and multiply it by the square footage of the building.
This method can get you into trouble if you use it as your final estimate. It can be wildly inaccurate because it does not include the actual scope of work but just an estimation of the scope of work.
I like to use this method to determine if an investment warrants doing further due diligence.
After you do a full scope of work estimate, or even better, have actual numbers from a few projects, you will be able to estimate what it costs for you to execute a specific renovation level. Here are a few ballpark estimates, though:
- Cosmetic $30/sqft
- Full Renovation 60/sqft
- Gut with Floorplan Change 75/sqft
- Gut with Additional Bathrooms $90/sqft
- Addition $100-$300/sqft
The disclaimer for all of these estimates is that it depends. Some houses need significant exterior work that can cost 30-50k, while others can be strictly interior work. Adding 50k on the exterior of a cosmetic renovation is definitely going to impact the per square foot cost and estimate.
Ballpark Lump Sum Estimation
This is likely the least accurate method for estimating rehab costs. However, it can be a little more accurate if you walk it with an experienced contractor. Basically, the idea of the ballpark estimation is to walk the property, compare it in your head with previous projects you have estimated, and come up with the total estimate for the property.
Here is an example. You walk a 2 story house that needs new mechanicals, cosmetic updates, drywall, paint, new flooring. You remember you either did a similar-sized project or had one thoroughly bid out in the past. It was slightly smaller and did not need a new roof, but it cost $60k. So you will take the 60k, adjust for the size of the property, say 5k, then add the cost of the roof. With the cost of the roof being 5k as well, you are now up to a ballpark lump sum estimate of $70k.
I think it is necessary to repeat myself, though. This method is extremely inaccurate. I have walked a property, though it will be a $60k renovation, and it is over 100k in the end. Hopefully, going through the full scope of work can catch these things.
Room Estimation Method
The room estimation method is like the Ballpark method, mixed with the scope of work method. Basically, you ballpark each room, add in the exterior and mechanical.
- Exterior: $15k
- Master Bath: 20k
- Upstairs Bath: $10k
- Hall Bath: 3k
- Kitchen: 30k
- Bedrooms: 5k
- Dining/Living: 5k
- Mechanicals: 15k
- Total: 103k
The problem with this method is that a lot of the trades might be quoted by the size of the house. For instance, you don’t typically get a drywall bid per room. It might be $20 a sheet for labor, $10 a sheet for materials. Then you have to calculate how many drywall sheets will be used and end up with a figure for the whole house, not per room.
It can also be very inaccurate for similar reasons to the Lump-sum method.
Running through these exercises for estimating can help sanity check your result. If you do a scope of work estimate for $60k but have done a similar project and it cost 80k in the past, or a contractor/other investor walked it with you and gave a ballpark figure of 100k. There is likely something wrong, and you should double-check your work.
What if the Budget Runs Over?
When renovating a distressed property there are often cost and time overruns. This is because unexpected things come up during the construction process. You may uncover problems that require further fixing, miss-estimate the scope, or the original plan doesn’t quite work out.
This happens with even the most experienced people in the construction trade.
To deal with budget overages, it is important to have a line item for contingencies. I recommend budgeting at least 10% for the unexpected. If this is your first house, you should at least double it to at least 20%.
One example of an overage in a property I was renovating is that in the demo phase we discovered the joists and ledger board were rotted out in an addition. There was no access to the crawl space under the addition so we did not know about this before we started the project. This added a few thousand dollars of additional framing to get the house together.
As you get more experienced you will learn how to avoid the obvious pitfalls of miss-estimating projects.
Financing a Renovation
If you are renovating your primary residence, there are many options for acquiring financing. You can get a home equity line of credit. If you have equity in your house presently, you could do a cash-out refinance and use the proceeds to fund the renovation. There is also the possibility of the FHA 203k renovation loan. You can also get a portfolio loan from a bank.
If you are a house flipper working on an investment property there are still some good options. One popular solution for flipping houses is a hard money loan. These have comparatively high-interest rates. The benefit to these is the loan underwriting spends more effort at looking what the after repair value is. They then back into how much it will cost to do the renovations and how much spread there is between the ARV and the purchase price.
Hard money loans are very similar to private money. The difference is that usually, hard money lenders are specifically in the business of making loans to individuals to flip with. Private money lenders are typically sophisticated investors or friends and family who invest in a variety of assets.
Finding a Renovation
If you are house-flipping, then finding a property to flip is one of your main tasks. You will want to look for something that is in your comfort zone for renovations. This will vary for everyone. If you are looking to make a sustained business by flipping houses, then you should continually work to press that comfort zone. Expanding your circle of competence.
Since large-scale renovations cost a lot of money, you will want to do your due diligence before purchasing. You will also want to get several quotes on the big aspects of the renovation before closing.
You can find properties through a wholesaler. These are investors who contract directly with sellers and then flip the contract through assignment. Depending on the real estate market, you may be able to find a property on market using a real estate agent.
Helpful Automation
Takeoff software can help you be more accurate and faster when estimating rehab costs. For example, if you are hiring an architect or designer to make a set of plans for this project, you can use these plans in takeoff software to better estimate the scope of each task.
A tool that I use for this is called Stack. It runs in your web browser and is very easy to use. There are both free and paid versions of this software. With the paid version, you can set it up, so it gives you estimates on material and labor based on the “assemblies” you add to a specific takeoff. The free version is great for measuring square footage, getting linear ft of walls, etc. It is enough to then plug into your own calculations to figure out things like wall area, how many boards or drywall are needed, etc.
Architecture
If this is a big project where you will have plans made by an architect or designer, it is typically best to run the numbers before you have the plans. Then once you have the plans finalized, go through the process again with the specific items that are called out in the plans. This way, you are less surprised by the costs you come up with after paying for plans.
Conclusion
One of the critical roles of a real estate investor is being able to estimate rehab costs. While the task may seem daunting at first, the best way to deal with it is to break it down into smaller pieces. Then after it is broken down, dive into what is required for each portion of the job by scoping out the work. Then once you have it scoped out, you can start estimating what each unit will cost. Finally, once you have the costs estimated, you can put it all together into a budget for the renovation.
