If you look at big metropolitan areas, such as Los Angeles, Chicago, or Houston, it seems that high-rise apartment buildings are being built nonstop. These sleek glass and steel structures appear as if they’ve been lifted out of a postmodernist masterpiece.
But despite the incredible appeal of these skyscrapers to renters and real estate investors, there are still good reasons to renovate old properties, rather than build news. Basically, it boils down to three factors: price, convenience, and potential return on investment (ROI).
Renovation is more affordable
In the United States, construction costs, especially in an established market with plenty of existing buildings (say, an old, space-strapped city like Washington DC or San Francisco), are extremely high. This makes it impossible for all but the biggest, richest companies (or consortiums) to fund, plan, and construct new structures. Individual investors and small- to medium-sized real estate firms are very limited on what they can build.
Take New York City: In 2015, the New York Building Congress, a trade association for the construction industry, estimated that New York’s costs were double the national rate, rising by 5% for three years in a row. True, 5% might be low in comparison to the boom years of 2006 and 2011, when costs reached 12 and 11% respectively. Still, if the average construction cost of a new apartment is $1,000 per square foot, then clearly apartments are being rented (and sold) at astronomical rates.
The reason for this high cost? Overzealous regulation and endless bureaucracy. The cost of building permits, particularly in a metro area with lots of old infrastructure, historic buildings, and confusing, overlapping underground construction, is also incredibly high. Legal protections that property owners have on and around where construction takes place also drive up costs. Add in expenses for labor, materials, and equipment, and the price of any building project can become shockingly expensive, like the $4.16 billion Cosmopolitan Las Vegas.
Given these high costs, what’s the better alternative to building from scratch? The answer is to rehab existing residential properties. Compared to construction, renovation is much cheaper. Though costs vary by place and location, rehabbing is nearly always cheaper when compared to constructing a new home.
Consider New York City again, where the average construction cost is $1,000 per square foot. Building a 1,000 square foot apartment would run you $1 million. In Manhattan, the average cost of a rehab project for a similar home is just under $118,000. It’s more than eight times cheaper.
Renovation is more convenient
The main benefits of renovation include the fact that you don’t need as many materials, can make good use of existing structures, and nearly always spend less money. In addition to these, there are many other pros to rehabbing an existing housing unit, including:
- The home will fit right in with the surrounding neighborhood.
- The home can easily be made more energy efficient with features like argon-filled windows and modern appliances (you don’t need a complete overhaul).
- You can convert the building into more or less units. If you’re an investor trying to maximize ROI, this is very important to consider. Additions are possible as well.
Some may be hesitant to renovate due to the presence of hazardous materials in older homes. This issue can be easily solved by only purchasing housing structures built in the 1980s or later. Many of these may be dated, but you won’t have to be concerned about things like lead—which was banned in 1978.
What it comes down to ultimately is this: As long as you don’t have to completely gut the place (in which case you may want to think twice about the investment anyway), rehabbing something like a multifamily home is always cheaper than starting from scratch.
Rehabbing residential properties is also much quicker. You don’t need to go through the land acquisition process, get permits, deal with overages, and manage an unpredictable timeline.
With the right remodeling team, a home rehab job, consisting of renovations in the kitchen, bedroom, living room, and other rooms, can be finished in one to six months, depending upon the scope of the job. Building a new home takes six to 12 months, or longer if authorization and permits get held up. If you’re buying a property with multiple units, the time you save is even more. On top of all that, you’re limited in where you can build new construction, while existing homes are literally all over the place in any city or suburb.
Renovation offers better ROI (if you do it right)
Knowing the cost and obstacles associated with building (or rebuilding) a residential property, it makes sense that renovation could bring you better ROI. That’s because you’ll be able to get the property on the market sooner and at lower startup cost.
To achieve the best ROI, you have to do the renovation properly (of course). Put in all the shiny new features to attract renters, like hardwood flooring, granite counters, and stainless steel appliances. And avoid overspending, not paying attention to curb appeal, leaving in outdated decor, and other common mistakes. Also, keep in mind that even the best renovations won’t bring you good ROI in the wrong market. Your investment should be market driven.
For instance, at MZ Capital Partners, we specialize in multifamily assets and specifically seek out properties with historically high occupancy rates (90% or greater). This ensures we can get immediate cash flow as soon as a property has been successfully renovated. It also ensures we don’t have to spend as much on advertising, as people in the area are already familiar with the building.
Winning by renovating
Unless you have unlimited cash at your disposal, the most efficient way to start making money in real estate is to rehab existing properties. Just remember: Investing in housing in healthy rental markets guarantees that you can fill the vast majority of units. And, if you renovate the place well, you can also even increase demand and drive up the price of rent—which leads to even greater returns on your real estate investment.