For several weeks now, I’ve been blogging about investment opportunities in distressed properties. As enticing as these opportunities can be, I also have to issue some caveats about when and how they can be the wrong step to take for some people.
Take my client John (not his real name). He’s a wonderfully optimistic go-getter who’s been looking for a fixer-upper for his family. He frequently says to his wife, “If the house we buy isn’t exactly what we want, I’ll make it what we want.” If it has only one bathroom, he’ll put in a second one. If the kitchen needs to be remodeled, he’ll tackle that. Landscaping lacking? He’ll redo it.
But in these situations, I feel like it’s part of my job to push back on some of these dreams so they don’t turn into nightmares later.
I asked him about his remodeling and carpentry skills. John admitted he didn’t have all the skills, but that he could learn.
I asked him how much a kitchen remodeling, for instance, might cost. He estimated about $30,000, less if he did the work himself.
I asked him about paying for these improvements, reminding him that he was currently at the top of his qualification range. He was putting all his cash into a down payment of 3.5%. His response was that they could get a line of equity on the house to finance the remodeling.
I had to deliver bad news about today’s market. You can’t get cash from property anymore unless the loan is 75% of the property’s current value or less. That means with a 97% loan, he can’t get a home equity line until the house increases in value sufficiently for him to reach that 75% mark. We ran the numbers, and it would take nine years at 3% increase each year to reach that point. In a real catch-22, the value of the property won’t increase that much without an updated kitchen.
John talked about saving $500 per month to finance it, even though he wasn’t currently saving that much. Even so, we ran the numbers, and it would take five years to save enough to remodel the kitchen.
John is now looking at his decision with a completely different perspective.
Fixing up houses to live in them or flip them is a viable dream — as long as the finances are there to support the effort. So be sober when you consider a fixer-upper. And if you’re an investor and you’re selling to someone who wants to do this, to avoid the liability, make sure they have the resources and capacity to do what they say they want to do.
