The Renovation Delusion

Many people think that they can strike it rich from buying houses that need major renovation work, transforming those fixer uppers into beautiful homes and then reselling them for a huge profit. They see it on TV, on YouTube and hear stories from friends and family about the fortunes made from rehabbing junkers. But is that business model actually highly profitable? What you're about to discover is that they have the Renovation Delusion! You'll learn what the delusion is and how to correct that flawed thinking. EVERY real estate investor needs to watch this video!


Do You Have Renovation Delusion?

So many real estate investors when they first get started have some level of renovation delusion. This costs them money and time. And the worst part is many don't even realize they have this delusion. Well, before you can diagnose whether you suffer from it, you first need to know what it is.

 

Diagnosing Renovation Delusion

 

Here’s an illustration you may be able to relate to. I received a message from a beginner real estate investor looking for my help. Here are the deal parameters he laid out:

  • The property was in Texas and listed for $40,000.
  • He estimated the rehab would cost about $40,000.
  • He anticipated it selling for about $120,000 when renovations were completed.
  • Making him $40,000 in profit.

He said in his message that this was a big opportunity and that he needed my help. In fact, he said, "Phil, show me the money." So, I'm going to ask you this question. Is this a big opportunity? If you said yes, then you have renovation delusion.

Flawed Thinking

Now this individual was quite transparent, and I appreciated his honesty. He went on to say,

"I'm not that confident that this is going to be a $40,000 renovation cost. I've never done anything like this before Phil. I'm trying to estimate the best I can, but I just don't know for sure. A lot of different contractors would be involved. I would need help estimating the renovation costs and hiring the right contractors."

You see, he had seen my video Seven Things to Never Say to a Contractor, and was a bit nervous about working with them and understandably so. He had also watched my teaching called Predicting Final Sales Price. Because of this he wasn't confident in his estimated $120,000 sales price either.

This beginner investor had a third problem. He didn't have any money for the down payment or the rehab. Since the property was listed, he would need to use hard money. So, in reaching out to me he was looking for money, and expertise on renovations and estimating final sales price. He was looking for the whole works and this is where the delusion comes in.

This is NOT a Big Opportunity

Even if you are positioned to overcome these challenges and have everything lined up perfectly. For example:

  • You have the money
  • Know exactly what it will cost for the rehab
  • Have excellent contractors
  • Can get quality products inexpensively because you have great relationships with suppliers
  • And can get maximum sales price for your property

Even in this scenario, this is NOT a big opportunity.

 

Cure Your Flawed Thinking

 

After studying this at a level probably never done in history and putting a microscope to this business using every strategy and tool available, I have come to conclude that this model of major rehabs is NOT a big opportunity. Instead, you should sell these properties as is.

Now the property in my example was listed. As you probably know from my other teachings, if the property is listed and hasn't sold yet then it's not even at market value. We try to get deals off market and then put them on market. This model is best done as an entrepreneur. As someone looking to make a profit and is best monetized by selling AS IS to someone else.

I first shared this discovery on a video 11 years ago called The Secret to Flipping Houses. It illustrates mathematically why this is not a big opportunity and that lesson has held true all these years. Now that we know what the renovation delusion is, let’s find out why this delusion exists and if there are any exclusions or factors you need to be aware of.

 

2 Reasons People Fall into the Renovation Delusion Trap

 

1. It Makes Sense on Paper

Where does this renovation delusion come from? To some degree, it comes from people looking at this on paper and thinking it makes sense. Normally in life if you have all these skills it would mean that you would hit your payday. You improve every step of the way, the pieces of the puzzle build on top of one another and you're very successful. Which is why it’s so easy to fall into the trap of the renovation delusion.

 

2. Entertainment Makes it Look Easy

The fact that it's become entertainment on major networks, such as HGTV and others like it and some YouTube channels, exacerbating the issue. There's entertainment value in taking a junk, fixer-upper and turning it into something beautiful. But have you ever noticed that on the more successful HGTV programs, the stars of the show are typically a couple, one's a contractor and the other is an interior designer and they charge a client to do what that client wants? And what happens if they go over budget? They take things out or the budget gets increased. Either way, the stars of the show will make money. That model works because they aren’t betting on the profit coming from the sale. They are also given materials for free or at a major discount by the suppliers because they mention it on the show.

So, when someone watches the show, they think to themselves, “I'm going to buy an ugly duckling and turn it into a beautiful swan and make all this profit”. It’s just not real world. When you dig underneath the hood, you find out that the model doesn't actually work for you in your own backyard because this model is flawed.

 

Real World Investing

 

If the solution to renovation delusion is to not do the work but to sell the property as is, what if other people come to the same conclusion? Who do I sell to? To answer that, I’ve embellished a P.T. Barnum famous quote,

"A sucker investor buyer is born every day."

Who are those people? Those are people that are buying properties as an investor and think that a major rehab project is a big opportunity. And I'm not just talking about a novice that's been watching HGTV, I'm talking about people who fall for it because this is such a seductive trap.

I've even seen experienced investors take on a little bit too big of a project and that's all it takes. They learn their lesson six months later and say they will never do it again. Then two years later, they forget that lesson and they go right back to it.

Is this Ethical?

My own brother did this. He bought a fixer-upper and thought it'd be fun to do some renovations on the weekends. About month four he was miserable, and he called me up. When I asked why he didn't just get it under contract and flip it, he said, "But Phil, if I did that, I wouldn't add any value to society. By fixing it up, at least I'm providing a product out there. I'm not just the middleman."

The problem is, if you want to be profitable in this arrangement you must be the middleman. I can't fix the dilemma that by being the middleman, you're not "adding a tremendous amount of value to society". I’m showing you that it is best monetized by selling to a sucker investor buyer.

I get some complaints about this phrase and how it’s wrong to pawn off your problems to some sucker. This is misguided because that's not what's happening in the real world. When we get a property under contract and put it on the market, the buyers are the ones investigating the property and making offers. We are simply operating in the mechanism of the marketplace. If the market is willing to pay $ 50,000 or $60,000 for a property we have under contract for $40,000 then so be it. Just because we know that it's probably not going to work out doesn't mean we've done anything ethically wrong. We just put it on the market as is, disclosing what we know is wrong with the property and we let somebody else fall into the trap of the renovation delusion.

 

3 Exceptions to the Rule

 

1. A Light Cosmetic Renovation

A light rehab is completely cosmetic and includes things like paint, flooring, door handles, light fixtures, and maybe some landscaping. It does not involve getting permits or a major overhaul of a kitchen or bathrooms. It will not require a large budget (unlike my example where the rehab was the same amount as the purchase price). If a sledgehammer is being driven through a wall you know it’s no longer a light cosmetic renovation, and that's when you’ll discover problems that can cost you money. As real estate investors we are trying to maximize profit while doing the right thing for everybody involved in the transaction. I'm not saying you cover up problems, but don't go looking for them.

It will be up to each investor to determine when they’ve crossed the line to major renos. For example, is a roof that needs a permit is it light cosmetic or is that major renovation? Well, if you have a great roofing contractor and you know there's nothing else major going on in the house, then maybe that's okay. So, there are shades of gray, but when in doubt sell it as is. Why? Because a quick nickel beats a slow dime.

There are times when deals will make more money if you completely renovate them versus selling as is. But overall, a quick nickel is going to beat the slow dime because in the real world, it's not actually double. It's not a dime. Usually, what happens is a quick nickel is going to beat a slow nickel. I can't tell you the number of times people have told me that if they had just sold it as is they would have made more money than after all the work and renos.

 

2. Converting a Mobile Home into a Manufactured Home

This is an exception as well because it does require permits sometimes. When the property has a mobile home with its own title, you retire that title and convert it to become a permanent part of the property. The benefit of doing this pertains, not only to the tax assessor and the register of deeds, but also to a lender. Now that mobile home, which previously couldn't have been borrowed against for a Fannie, Freddie FHA, VA, USDA rural loan, can get a conventional loan because you've turned it into a manufactured home with a permanent foundation. This is a huge move that’s making people a lot of money right now, especially because of COVID.

 

3. Renovating a Long-term Property

The third exception is when renovating a long-term property. A good example of this would be a vacation rental, but it also could be for a traditional rental as well. I have a video coming out where I take you inside an ocean front vacation rental and show you the before and after of a major renovation I did there. But here's the beautiful thing about a long-term hold; you have 5, 10, 20 years to make up for any mistakes you made early on. You're not betting on that immediate resale. Instead, you’re betting that over time you will have cashflow and will refinance out whatever you invested, allowing for a much higher return on investment. And of course, you hope it appreciates in value as well.

 

Conclusion:

Regardless of how much money, experience, and skilled contractors you have doing perfect work, or how skilled you are at selling a property, when you're dealing with a major renovation the best way to monetize is to sell it as is to a sucker investor buyer. You will be more profitable and have more free time to enjoy life. And ultimately it will make you a better real estate investor. There are some exclusions, but when in doubt, sell it as is. Sell it to somebody else because a quick nickel beats a slow dime.

 

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Comments

  1. Armandine Jacotin says

    As usual, great information Phil. I always thought that is something good to try to do. Now I know better. Are you saying that even if he ended up spending 15 to 20 thousand more, and got 120 in the sale, it still wouldn’t be worth it? Or might it be that he could not get that 120 for it because the median price in that neighborhood is only 100 thousand or so?

    • Phil Pustejovsky says

      I’m saying you will make more money but nor embarking on a major renovation at all! But instead, sell those properties as-is and let the market pay too much for it.

  2. Dear Phil:

    I own a 3 bed, 3 bath condo on the 15th floor of a high rise building on the ocean with great views of the ocean from the front and beautiful views of sunset looking out the back at the intercoastal and 2 cities in Broward County, while having dinner. It is a luxury condo with many amenities, that is for sale. The real estate fees are $42,000 and I owe $450,000, plus another $25,000 in legal fees, county stamps and closing costs. A person wants to give me half the asking in cash and wants to rent the condo as partners for about 3 or 4 years and then sell the condo for a profit as the value should increase. That person wants to leave the marble tile floors, but buy a new dining room table and chandelaire lighting and buy a few new appliances for the kitchen to help obtain a good rental! The person asked where could one put the funds to get more income with tax write-offs. Does that sound reasonable?

    • Phil Pustejovsky says

      You don’t hear those terms everyday! Sounds like a lease option whereby you get a gigantic option payment upfront. So long as that payment is nonrefundable, and the final option price is reasonable to you, that may make sense. Also, you’ll need to be able to evict him if he doesn’t pay the rent.

  3. Phil, you’re the greatest! Thanks!

  4. Zack Clarke says

    Great video Phil. Can you make one on creative financing for commercial property? I have some cash but not enough for 30% on most commercial deals and have reserves.

  5. I bought a house for $35000.00 rehab around $20,000 mostly materials because my husband does the work and we sold it for $172,000 and the new one we bought for $51,000.00, $20,000.00 for rehab and listing it for $140,000.00 so it’s worked for me

    • Phil Pustejovsky says

      How many hours was your husband working? That has to be factored in. Materials alone is not rehab costs. Furthermore, you probably could have sold it as-is for $110,000 and $90,000, respectively. Had you just sold it as-is, you would have probably made just as much, or more (if you factor in the labor costs).

  6. Mehiar Mehran says

    I am impressed by your honesty.
    I have a general contractors license in Denver Colorado. Want to get into flipping houses but am too scared to do anything in this market. Need mentoring.

  7. Gernot Ritzau says

    I don’t agree with you 100%, the problem we have is, that complete novice rehabbers are coming in and pay top dollar for junkers. They take a perfect business model. For someone like me that likes getting down and dirty, I Don’t mind the torchure of rehabs!
    I am not a paper pusher that likes nit picking around with motivated sellers about what their beauty is worth…I like to buy the john and make it castle again…

    • Phil Pustejovsky says

      You are proving my point that there a Sucker Investor Buyer is born every day. If you want to get paid to get down and dirty, then get your contractor’s license and become contractor.

  8. just sell it as is!

  9. love yr show

  10. You are the man Phil! Always keeping it real! Thank You

  11. Willy Jarboe says

    Was impressed with the video because it was a lesson on wasting money on renovations which might actually be nothing other than a vision and a money pit. We have to choose carefully what renovations are worth investing in and the renovations that won’t be profitable to the discoveries. Opportunities are available we may induldge to keep rather than hand off to the highest bidder or abandoning. Very informative and maybe a rude awakening for the dreamers and visionaries full of probable imagination.

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