One of the most consistent problems that new investors have is that they think they can get away with rehabs on the cheap. For one thing, you pay what you get for. Don't hire some subpar contractor who pays a bunch of sketchy semi-employable people under the table to do your rehabs with a mix of cheap materials, used materials and possibly stolen materials.
Secondly, projects usually take longer and cost more than you expect. This is especially true for new investors, but even experiences one's can get burned. The Sydney Opera House was supposed to cost $7 million dollars and take four years to build. Instead it cost $102 million dollars and took 14 years to build. Oops!
If such a project can go south, so can yours. Daniel Kaheman gives several more examples from his excellent book Thinking Fast and Slow,
- The Scottish Parliament building was budgeted at 40 million euros and ended up costing 431 million.
- A 2005 study of rail projects concluded that on average, planners overestimated the number of people who would use the new rail system by 106 percent and underestimated the cost to build by 45 percent.
- A survey of American homeowners who had remodeled their kitchens found that the average person expected to pay just over $18,000 but ended up spending over $38,000. ( Pg. 250.)
This has certainly been our experience. I've had plenty of rehab projects go over budget, but very few come in under.
So when preparing a rehab budget, first note that a contractor's bid often doesn't include many vendors (HVAC, carpet, appliances, etc.). Furthermore, there will be add-ons and change orders, I guarantee it. And in addition to that, you have holding costs.
So make sure to add in at least an extra 20% on top of the what you think it will cost, and at least a week, probably more depending on the size of the project. And of course, the big key is to get really good deals. This will leave you with the margin you need if there are problems with the rehab. And trust me, there are always problems with the rehabs.
Don't expect everything to go right, it rarely does. If you build in that contingency and do the proper planning up front, you should be able to avoid the normal pitfalls of rehabbing that most real estate investors fall into.