Adding a bedroom and $300 in cash flow
One of the most common ways real estate investors generate positive returns on a property is through appreciation. Yet, when properties are being sold at all-time highs, the potential gains from appreciation are limited and finding a deal with equity is nearly impossible. When homes that appear to have equity hit the open market, that equity quickly erodes as buyers enter into a bidding war.
In markets where home prices are at all-time highs, real estate investors have two options: stay on the sidelines or get creative. In this post, I will share one of my experiences purchasing a home in a hot market, adding value by adding a third bedroom, and immediately forcing appreciation and justifying a rent premium.
In 2016, I bought a 2 bedroom / 1 bathroom single family home in the San Joaquin Valley in California for $250,000. The home sits in a Class A neighborhood, surrounded by other well kept homes, and is located directly across the street from a university.
The home was originally listed for $275,000 in July 2016, but after not getting any offers for a month, the seller decreased the price to $250,000. While I do not know this with certainty, I am guessing interested buyers thought that $275,000 was too expensive for a 2 bedroom home.
Lesson #1: 2 bedrooms homes with at least 1,000 square feet. During the Summer of 2016, I was ingesting every real estate investing resource available. I had 3 rental properties in my portfolio and was eager to purchase more. No resource was more valuable than the Bigger Pockets podcasts. On one of the podcasts, Brandon Turner mentioned that he sets a Zillow or Redfin alert when properties that have 2 bedrooms and at least 1,000 square feet are listed on the market. Through his experience, he has seen that homes that have more than 1,000 square feet typically have the space for a 3rd bedroom to be comfortably added. I thought I’d try it out myself and did the same for a neighborhood I really hoped to invest in.
Lesson #2: Keep an open mind when walking the home. In August 2016, I received an alert for a property that met this 2 bedroom and at least 1,000 square feet criteria. It was located exactly in the neighborhood I wanted to invest in. I immediately asked my realtor to schedule a walkthrough. As soon as I entered the property, I noticed that the home’s existing dining room could be converted into a third bedroom. While the dining room had three entry and exit ways, I could envision walls that had been cut out and a water heater that needed to be removed to make room for a closet. Realizing the opportunity to convert the dining room, I immediately made an offer to purchase at $250,000. My offer was accepted shortly. Two months later and after $7,000 spent on ripping out carpet, refinish the floors, adding a sliding glass door in the bathroom, enclosing the third bedroom, and relocating the new electric water heater, the home was ready to rent.
Lesson #3: Historical rents do not imply market rents. While under contract, I had been constantly looking at the rent that similar homes in the neighborhood were asking. Average rents for a 3 bedroom / 1 bathroom in the area were approximately $1,500 per month, but I knew my home could command a higher rent rate given that other rental properties only lasted on the rental market for a few days and my home was in a much better condition. Given the home’s proximity to the local university, I also knew there would be university students that would prefer to pay a premium to live in a house rather than pay the amount commanded from on-campus housing. I ended up listing the home for rent at $1,900 per month and was able to screen and sign a rental agreement within 1 week of listing the home. The $1,900 a month rent allows me to cash flow $300 a month.
There still are deals to be had when prices are high, it just takes a bit more creative thinking. Adding a bedroom to a home and challenging the status quo of historical rents is one strategy that I have had success with. Following these three lessons will help you immediately identify value and force appreciation or cash flow.
Lesson #1: 2 bedrooms homes with at least 1,000 square feet. Setting up an automatic alert on Zillow or Redfin can help you save time in your search, and when a home meets this criteria and is within your budget, schedule a walkthrough.
Lesson #2: Keep an open mind when walking the home. Look for areas within the home that could be better utilized. For example, ask yourself if a dining room or a bedroom can offer higher returns, or if an extra large bedroom could be converted into two bedrooms.
Lesson #3: Historical rents do not imply market rents. Demand for a place to rent is always increasing, so rental rates should increase to unlock more supply. Do not stick with the status quo of what your neighbors are charging, but set your rent rate at a number that makes the most financial sense.
Even in markets where home prices are high, there are opportunities to force appreciation and add value to a home, namely adding another bedroom to a home. Following these three lessons will help you find discounted homes and questioning the status quo of historical rents will help you cash flow.
