Capital Improvements vs. Cosmetic Projects: How to Effectively Improve Your Rental Property
What improvements make the most sense when improving a rental property?
Deciding when and what improvements you should complete on your rental property can be a tricky decision. Unlike choosing what renovations you’d complete on your own home, rental property improvements are a business decision that should be based strictly on financials. You will want to make sure you are making improvements that either improve the overall value of your property or allow you to increase rents. If you can’t do either, then the improvement does not make sense. In addition to which improvements to make, timing must also be considered. I generally suggest to never make cosmetic improvements until a unit is vacant, however capital improvements can be done virtually anytime. This is because capital improvements are usually not unit specific whereas cosmetic improvements are unit specific. Ask yourself these simple questions to aid in the decision-making process:
How much will this improvement cost and how much more rent can you get as a result?
How long will it take you to make that money back?
Is this improvement really necessary or is your decision based on what you would like if you lived there?
Is this improvement consistent with the neighborhood and surrounding area?
Ultimately you want to make sure you are not over improving for the neighborhood and local rental market or under improving which will hinder your ability to maximize cash flow. Considering all angles will help you make the right decision.
Capital Improvements vs. cosmetic Improvements
Cosmetic improvements like painting, replacing cabinets and countertops or adding new flooring allows landlords to charge a higher rent rate and also sets your rental units apart from your competition. Giving your tenants a clean, well-kept and cosmetically appealing apartment to live in will also go a long way to setting a standard on how you expect your tenant to maintain their unit. Capital improvements like replacing the roof, separating utilities, replacing windows or adding bedrooms and bathrooms increase the overall value of the building as well as impact your cash flow. Separating utilities allows you to turn that expense onto your tenants and will decrease the overall expenses you pay on a building. Replacing windows could have a direct impact on a tenant’s utility cost. Tenants that have very high and expensive heating or air conditioning costs tend to move much quicker than those that have controllable expenses from well insulated buildings. This directly impacts your bottom line because turnover is costly — you will want to consider how or if your capital improvement relates to your tenants’ overall comfort before making any final decisions.
If my building does well now, should i do any improvements?
It all comes down to cash flow. If you can increase the cash flow or value of the building then the answer is yes. If you can’t, don’t! When you make the best, most cost-effective improvements to your rental property, your cash flow increases and so does the value. Completing the right improvements can help you:
Reduce your rental property maintenance and operating costs — Lowering your out of pocket landlord expenses each month equals a higher net income — meaning more cash in your pocket! One of the most efficient ways to lower landlord expenses is to install sub-metered devices to a multi-unit building. This relieves the landlord from paying all utilities and allows the tenants to be billed separately.
Attract and keep higher quality tenants — When your property is updated, well-kept and isn’t overflowing with maintenance issues, you will attract higher quality tenants that stay longer. Quality tenants are likely to pay rent on time and take care of the property. If they are comfortable and enjoy the place they live, they will most likely stay longer.
Increase property value and rent — By adding upgraded, functional utility to your property you can significantly increase its value while making it more appealing to prospective tenants who are willing to pay more. Increased cash flow = increased value.
Stay competitive in the rental market — You’ll want to check out your local rental market and see what is available. If all the rentals are upgraded and provide more conveniences than yours, renters will likely choose those other properties even if they come at a premium. No one wants to live in a dump so make sure your property does not look like one!
How DO You prioritize improvement projects if you’re on a budget?
First, you’ll want to determine if your building is costing you money or not. Take an inventory of ‘repeat offenders’ and make those projects a priority. Issues that you are spending money and time frequently fixing are the best ones to start with. If you have a leaking roof that you have to keep patching, you should consider replacing the roof. Constant band-aids rarely work. If you have had backups or clogged drains frequently in your building, you should consider having the lines scoped to see if there is a larger issue that is contributing to it. Ignoring the repeat problems can put you at risk for more costly repairs to your property. Water is typically the number one offender in property damage. It occurs many times without warning and it can be very expensive to repair. Keeping your building watertight is essential to keeping maintenance costs down.
Next, you’ll want to consider the comfortability and convenience of your tenants. A happy tenant is a long-term tenant. A long-term tenant keeps money in your pocket. Remember that capital improvements may not necessarily increase your rent rate, but they can be a factor in how long a tenant will stay. A tenant likely won’t care if a roof is brand new, but they will care if that leaky roof personally affects their day to day comfortability or damages their personal belongings.
Cosmetic improvements should be considered last if you’re on a tight budget. Make sure the project is worth it — ask yourself: Will I quickly recoup the cost of this project? How long will it take? Let’s say you want to upgrade a kitchen and it will cost $5,000, but by doing so, you only get about $50 more in rent a month. It would take 100 months to recoup the cost of that improvement. This would not be a wise improvement. I typically tell landlords if they can recoup the cost of the cosmetic improvement over 6 months, it is likely a good, cost-effective decision. More than that and you may just be over-improving the unit.
There is no one size fits all answer for any specific building or situation. The cost of the investment and the time to recoup the cost of that investment has to make sense. Be sure to do your own due diligence and weigh the factors that influence both capital and cosmetic improvements before spending the money to make changes. In addition, make sure you know the market and what your competition is doing so you can make the most educated decision for your building.