Renovations are one of the fundamentals of a value-add business plan. Renovations are essential to achieving higher rental premiums as well as changing the resident sentiment toward the property. Renovations can be as simple as painting a common hallway or as complex as gutting every apartment unit and rehabbing them.
Major renovations include repairing, replacing, or installing capital expenditure items such as HVAC systems, roofing, windows, a playground, a pool, full apartment renovations, etc. The renovation budget in a value-add business plan is the largest expense besides the property itself. Therefore, property estimating renovation costs is critical. The most common problem is underestimating the total cost of the renovations. If renovation costs are dramatically underestimated, there may need to be a capital call (asking investors for more money) to finish the project or the project will not get finished, however, either way, this will negatively affect investor returns.
To properly estimate renovation costs, the project first needs a scope of work (SOW) and then the SOW needs to be split into labor costs and material costs.
Scope of Work (SOW)
The SOW is a to-do list of every item that needs to be completed for the project. The trick is to have an extremely detailed SOW from the start and outline clear expectations. The SOW should be easy to read and understand. There should be no room for assumptions in the SOW.
Contractors will read through the SOW and see the project firsthand and submit their bid. It is important to talk with the contractors afterward and receive feedback on the job. This will give important insight into what they think and see. Often, they think of things and see things that you will not. Once you have multiple bids, compare and contrast, and choose a bid.
Materials
There are two ways to structure the renovation. The job can be billed for labor only or for labor and materials together. When billing labor only, all materials are expected to be at the job site for the contractors when they are scheduled to arrive. Everything they need should be there.
On the contrary, a job can also be billed by materials and labor together. In this scenario, the contractors are responsible for gathering all materials they need themselves. The difference is in material cost. When materials are provided by the owner/managers, the materials are purchased at cost from the supplier. When contractors provide the materials, it is common for them to upcharge on the materials. With large jobs, it's very difficult if not impossible to provide all materials.
Labor
Labor is the majority of the budget. Labor costs can be billed hourly or by the job (bid). Every contractor has a different skill set and expertise and therefore each contractor will charge a different amount. A master plumber will be charging much more than an entry carpenter for their time.
On larger projects, it's more common to estimate a job by having contractors come out for bids (total estimate for the job, not based on hourly charges). Completing a job based on hourly pay is uncommon because then the incentive to complete the work is lower. If the work takes longer, the contractor makes more money, and the job then costs more. This is especially important because if the job is based on hourly pay and the time to complete the job is underestimated, the estimate will be way off.
Common Mistakes
Going with the first bid. The easiest mistake is going with the first bid. In a rare occurrence, someone can get lucky and have the first bid be good, however, more often than not the bids are drastically different. By getting multiple estimates, someone can compare and contrast them to choose which is the best fit
Underestimating how long a project will take. Contractors often rush the proposed timeline in order to win a bid, but during execution, they are not able to perform. It is up to you to understand and estimate a realistic timeline. Unfortunately, properly estimating the timeline comes from experience. It’s always a good idea to check with others that have experience if you are not sure.
No reserves were budgeted. Even in smaller projects, there are likely to be unforeseen problems occur. In a larger renovation, there is more opportunity for problems to arise. Reserves are included to act as a buffer for when something unexpected is found or something goes wrong. If there are no reserves in the budget and there is a problem, either a part of the renovation needs to be sacrificed to stay on budget or there needs to be a capital call (worst case scenario) to invest more money.
Estimating renovation costs is a true skill and is mastered from experience. There have been entire books about how to create estimates, monitor progress, and hire and fire contractors, however, these key points are a great starting point. No matter how many precautions someone takes, there are always going to be some issues arising. However, by defining the job, knowing the structure, having multiple bids, reviewing them, and keeping reserves, you should be able to accurately estimate renovation costs.
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