When searching for multifamily properties that will generate high return for investors, it is imperative to find a value-add component. Often, this value-add comes in the form of renovations that will improve the appeal of the units, thereby allowing for the rents of the property to be increased. Several discussions could take place over the strategies behind building this renovation plan, but today’s article will focus on constructing the budget for these renovations which is a key component that must be plugged into your underwriting analysis.
When a property first comes across our desk at Apogee Capital, one of the first things we look for is the presence of the above-mentioned value add component. Sometimes this is identified by simply looking at the marketing package, but typically it requires a tour of the property combined with a market analysis of local comparable properties and an eye for creative solutions. Once this high-level analysis has been completed on the property, we can begin the assembly of our capital expenditures (CapEx) budget. The first step is taking the renovations we believe the property needs and itemizing them. We then go through them one at a time and assign an estimate for the cost of that piece of the renovation. As always in our analysis we must follow the rule “that the analysis MUST be accurate or conservative.” What this means at this stage is that since we do not truly know everything the property requires, and we do not yet have any quotes we must be conservative in this estimate. The game from this point forward then becomes sharpening our pencil at each subsequent stage to move from conservativism to accuracy.
Once the property is under contract and we are in the due diligence proves, we can begin to refine our list of required renovations. Inspections will often reveal additional items that need to be addressed in the renovation or perhaps suspected renovation line items that can be eliminated after confirming they are not an issue. This step allows us to get a solid grasp on what the real itemized renovation will look like and allows us to update our estimated budget.
Once we are in the latter stage of the due diligence process and as we move forward towards closing, we will begin to get quotes for each of these line items to continue refining the accuracy of the budget. We typically like to see quotes from multiple contractors to understand what the range in pricing can look like while also comparing what is offered from each contractor and their reputation for quality work. Once this task is completed for each line item, you truly have an accurate capex budget.
While this is the 95% solution it is important to understand that the renovation budget continues to be a living document. Should additional items appear, or unexpected expenses arrive during one of the projects, you must have cushion to absorb these costs. Budget contingency is the one layer of conservatism that should never be removed from a renovation budget. While nothing will ever be 100% accurate, developing a CapEx budget in this systematic practical way can save a lot of financial headaches as you move forward with your multifamily project.
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