When an investor is first starting out, typically, they will focus solely on cash flow and creating passive income. The idea of having money flowing into your bank account, month after month, is an amazing prospect. However, the key to real, long-term wealth is adding equity to a property, and then converting that into cash flow down the road, as opposed to simply relying on cash flow alone. David Greene, who has 8 years of experience buying, selling, managing, and renovating properties, uses a simple tactic that enables him to increase the value of his investment properties. In our recent conversation, he explained how any investor could approach a deal and replicate his success.
Addressing Functional Obsolescence
The best way that David has found to efficiently increase property values is to find homes that conform to the real estate concept of functional obsolescence. According to Investopedia.com, functional obsolescence is a reduction in the usefulness or desirability of an object because of an outdated design feature, usually one that cannot be easily changed. Examples of functional obsolescence in real estate would be a floor plan that is too small, a property with a square footage that is incompatible with the typical family size, or having one bathroom in a market that demands property’s with two or more bathrooms. So, David’s tactic is to identify properties that have functional obsolescence relative to the surrounding properties and perform the required renovations to address the deficiency. If done correctly, the value of the property will increase by up to 30%, but only requiring 5-10% of that money to perform the rehabs.
Real World Examples
For David, anytime he can buy a two bedroom, one bathroom property that has more square footage than the other two bed, one bath properties, he will apply this tactic. Typically, he will turn the formal dining room into a bedroom, bringing the total bedroom count to three. Then, he will cut into the wall in the back of the existing bathroom and tap into the plumbing in order to make a second bathroom. As a result, David expects to see the property value grow by 25% to 30% while putting in a fraction of that value increase into the renovation.
Another example, and one of David’s favorite ways to increase a property’s value, is to convert outdoor patios into additional livable space. In Florida, which is one David’s go-to markets, many properties have “Florida Rooms.” These rooms are outdoor patio spaces that are covered with screens to keep out the bugs. David loves to target these types of properties. For example, his last deal was a three bedroom, one bathroom house in Jacksonville, Florida that had a covered porch in the backyard that connected the kitchen and a den. This was an ideal situation because the roof extended out, there was framing in place, and the concrete foundation was already poured, so David could easily turn that outside area into an additional 350 square feet of livable space.
First, David converted the den into a master bedroom. Next, he took two-thirds of the outdoor area and turned it into a second bathroom. Then, with the remaining one-third of the outdoor area, he extended the kitchen in order to relocate the washer and dryer to a different part of the house. The entire project cost $17,000, but by adding 350 square feet of livable space and converting the property from a 3/1 to a 4/2, the property value increased $35,000.
These are only a few examples of addressing functional obsolescence and the resulting increase value. What are some situations where you were able to apply this technique and be met with either success or failure?
Disclaimer: The views and opinions expressed in this blog post are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.