Saturday, July 13, 2024

Rehabbed or Pre-Habbed? Two Approaches To Distressed Real Estate

This week, I’m working on a comprehensive scope of work– and Matterport walkthrough- for a two-family on Detroit’s east side. The current owner doesn’t want to renovate it, he wants to sell it. But the idea is to give a buyer a product that is ready for a quick start to construction. Thus, before renovation, then, the property will be in a state of what I’m calling “prehabbed.” There’s several thousand dollars worth of value associated with knowing that a building has connected and functional water, sewer, and utility lines. The question is how many several thousand dollars. Real estate isn’t all about location, location, location. At the lower end of the market, it’s about whether you can affordably and decently renovate a building.

“I can do that cheaper,” a flipper will say.

Our case? Write up a comprehensive, detailed scope of work for everything that needs to done to the house. Explain it all in sufficient detail that a contractor doesn’t even have to go into the property to bid it. What if I want to change the type of windows? Just change a cell in the spreadsheet! This isn’t rocket science.

“I can do that cheaper,” a flipper will say.

But Will It Meet Code?

Yeah, well, no, it won’t. I suppose you could do it cheaper. And you can also renovate a house that won’t meet code, because they don’t enforce code here. As Kevin reminds me wryly, building code is the minimum finish standard required for you to not go to jail. You could use some lousy underlayment and install a grey vinyl plank floor. Semi-gloss white trim and cool grey eggshell wall paint. No wall insulation, because who cares.

You could be like this guy, who once “interviewed me for a job” by way of sending me around for a whole with his hustler of a field manager, who spent most of his time busting the heads of contractors and telling them that their prices for installing vinyl plank flooring and slapping up a fresh coat of a paint was too high, and who then made me an “offer” of full-time-plus salaried at $45,000 with no mileage, no benefits, and no health insurance “because he believes that you should have the opportunity to make your own decisions about healthcare.”

Attics in these old houses provide a ton of floor area to play with. In this case, I might even propose opening the floor to the room below and having a sweet penthouse that occupies the second and third floors. This would be preferable than the current arrangement, which involves only a set of stairs on the back porch, which is presently unconditioned space and therefore something we’ll have to address.
Process Improvement In A Notoriously Inefficient Line Of Work

House flippers and anyone rehabbing property at some scale to develop into below-market rental property, however, have problems with wasting time. They waste a ton of time with cheap contractors who cut corners and force things to be redone later. They also waste time with finishes that don’t hold up. In major residential rehabs I’ve worked on ($50-150k budget), there might be a dozen site visits before any construction work actually starts.

These include:

  1. The initial survey and walkthrough by the developer. (2.00-2.50 labor hours)
  2. The general contractor. (2.00 labor hours)
  3. The general contractor’s main carpenter. (2.00 labor hours)
  4. The general contractor bringing in his plumber. (2.00 labor hours)
  5. The plumber’s cousin, for reasons we’re as of yet unsure. (1.00 labor hour)
  6. The electrician. (2.00 labor hours)
  7. An outside, subcontracted third-party vendor of some kind, who has an iPad and a branded polo shirt. (0.75 labor hours)
  8. The mechanical installers. (2.00 labor hours)

In billable hours, we’ve already probably cracked a G or two, plus the time delay. And we haven’t even started construction. Nor do we have much in the way of a construction scope, and certainly not a Manual J. Our objective is about saving time. Time equals money. Preparing an exhaustive scope of work at the front end of the project saves anyone a ton of time, and it can save any of the people on this list from having to ever set foot in the property. (Which is good, because it was a little spooky in there during a crazy windstorm). In this case, we’re able to take all of this time and money up front, billing less for the work, and come out of it with a better, comprehensive product.

Prehabbed, An Interim Option

A rehabbed house I’m defining as what real estate investors call “turnkey.” I’m defining “prehabbed” as a ready-to-go construction project, much of the guesswork of which has been taken out by some intermediary (in this case, me). There’s a bit of a hierarchy:

  1. Distressed, vacant. Bankers scratch their heads at this one. House flippers and contractors know what to do with these. Generally, though, they’re either going to be delivering an inferior product or they’re going to be spending a lot of time getting the thing done.
  2. Prehabbed. In this case, you have a property that is gutted and ready for a full renovation. It comes with a scope of work, a full set of measurements, schedules, and everything. We’re saving time for developers and builders.
  3. Rehabbed and unoccupied. This is good, because you get a finished product– but then you have to get a tenant. A banker sees an unoccupied rental property the same way they see a distressed, vacant property. Depending on the market, unoccupied properties may also be frequent targets of theft.
  4. Rehabbed and occupied. Investors like this one. And banks like it. If banks like something, that means it’s, well, benign.

Given this hierarchy, we’re able to move from #1 much more easily to #3. The product that comes out of it is a full set of floor plans, a construction scope that focuses specifically on the building envelope, construction schedules, and a Matterport space that allow a contractor to bid the work without even going inside. This can, by our estimation, speed up any job of this size by weeks. Distressed real estate deserves better than the drab, flipper-grey vinyl plank flooring and the fresh coat of grey paint. Let’s make sure these buildings are code-compliant and habitable but also energy-efficient, comfortable, and affordable.

Interested in learning more? E-mail us.

Gutting a property removes a huge amount of risk– and uncertainty- that is associated with any renovation project. There are now a lot fewer things that you don’t know that you don’t know, to borrow my favorite Donald Rumsfeld quote. We now know, for example, that the floors are salvageable. We know that the only moisture in the house that is going to be a problem is in the basement. We know that the walls don’t indicate any notable water damage, dry rot, moisture, mold, or \structural deficiencies.

Nat M. Zorach

Nat M. Zorach, AICP, MBA, is a city planner and energy professional based in Detroit, where he writes about infrastructure, sustainability, tech, and more. A native of Lancaster, Pennsylvania, he attended Grinnell College in Iowa, the Kogod School of Business at American University, the POCACITO transatlantic program, the SISE program at the University of Illinois Chicago, and he is also a StartingBloc Social Innovation Fellow. He enjoys long walks through historic, disinvested Rust Belt neighborhoods at sunset. (Nat's views and opinions are his own and do not represent those of his employer).

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