Running a rental property is like a business. You want to avoid any instinct you might have to turn your rental house into your dream home. The desire to over-improve a property is most common with new investors. Some people just become excited about the opportunity to express their creativity or try something out on a rental that they are considering for their own home. That’s not how you want to manage your Solo 401k retirement account.
You want as many renters as possible to see themselves and their furnishings blending nicely into your rental property. Colors and textures should be neutral to appeal to the widest swath of potential renters. Carpets, appliances, and fixtures should be of similar quality to other houses in the neighborhood. When renovating, you want to modernize but it should align with the neighborhood regardless if it is low, medium, or high income.
Begin with the Basics
Whether this is your first renovation of a Solo 401k property or your tenth, the first priority is complying with local codes, regulations, and making it safe for tenants. This does not mean beginning by focusing on the color of the kitchen counters. It does mean evaluating the remaining life of the roof and cleaning out sewer lines if needed. It also means repairing handrails on stairs and possibly upgrading the electrical system. For comfort and energy costs it might mean servicing or replacing the HVAC and replacing windows. Your rental property needs a solid foundation before you started hanging chandeliers.
Later in a major renovation, you’ll be repainting ceilings and walls. Before you get there, think about making everything look clean and new for prospective tenants. That might mean replacing dingy old electrical switches, plugs, and covers. Even if the house is 50 years old, you want it to look clean and well maintained for years to come. The cost to replace window caulk before painting is a basic investment paying big future dividends. It can be a bad investment to remodel the bathroom with twin sinks while scrimping on the little items replacing clogged shower heads or repairing leaks.
Think Value Added
As a Solo 401k investor, you know that your value in a rental house comes from two sources. The rental income and the equity you gain from appreciation. Logically, a renovation does both by adding value and increasing rentability. Something else to consider is that intelligent renovation decisions can also save you money long-term. But because you’re in the rental business, cash flow is still king. There is a lot to consider when deciding which projects will deliver the most value.
Your project selection should be based on adding the most rent or equity for the least dollars spent. Besides the basic project (kitchen, bath, master bedroom), your value-added decisions should carry into the material selection, style, and contractors. Start with your budget process. It’s the rarest of projects that when finished comes in on or below the original budget. A good rule of the thumb is that once you think you’ve accounted for all the costs, add another 20%. The other calculation is how much additional rent you will bring in and/or how many months of vacancy will be avoided. The fewer months that it will take the anticipated cash flow to pay for the renovations, the more value-added the project is.
More follows about the value-added projects and materials but first consider the right contractor. Unless your Solo 401k is invested in high-end houses, you don’t want a contractor that works for the rich and famous. Just like you don’t want to turn your rental into your dream home, you don’t want to hire contractors that specialize in fancy houses with specialty and custom installations. Your remodel is targeting the broad middle-of-the-road market. Likewise, your contractor should mostly work on affordable homes and apartments.
Rental Property Renovations with the Greatest ROI
Renters and buyers aren’t very different in what they prefer when it comes to an updated home. It’s well established that the order in descending preference is the kitchen, bathroom, master bedroom, and living room. It’s also well known that very few (if any) major remodels return the full investment when the property is sold quickly. That’s another reason to maximize rental cash flow, minimize costs, and make the sale value a distant third. Here are a few reasonable estimates of project costs (in 2021) and return on investment in the form of equity. It mostly matches with renter preferences, so you can expect it to increase renter desirability.
- Minor kitchen remodels should typically cost about $26,000 while increasing the resale value by 72% or about $19,000.
- Mid-range bathroom remodels should typically cost about $24,500 while increasing the resale value by 60% or about $14,500.
- Upgrading to a master bedroom suite (includes master bath) should typically cost about $157,000 while increasing the resale value by 55% or about $85,700.
Depending on your project needs and budget, you could be pleasantly surprised from inexpensive options available. The number one issue in kitchens is a lack of counter space, cupboards, and poor lightening over the stove (not the stainless steel appliances). Of course, a fresh coat of paint does wonders. BobVila.com suggests a neutral color scheme. Try 60% for the main color, 30% as a complementary color, and 10% for an accent color. Kitchen counters and finishes rarely need to be granite or fancy but do need to be easy to clean and long-lasting (resin-based or laminate countertops).
There are also some interesting thoughts about bathroom renovations. Many areas require that landlords pay for water, not renters. Replacing an old toilet with a ‘low-flush’ toilet will pay for itself by saving you in water costs. Another interesting tidbit is that people want more room in the bath. Reducing a double sink to a single sink adds space and will be much less expensive than replacing a single vanity with the plumbing needed for two sinks. Another bathroom thought is about our aging population. Most seniors plan to remain in their rental as long as possible and this age group values a renovated bathroom more than a renovated kitchen. If your target market is seniors, think about walk-in tubs, handrails, and other amenities for seniors.
Your Solo 401k bottom line: You want to do your homework to estimate the increase in rent that will result from the renovation and calculate the return on the property’s renovated value if you were to sell. If the numbers don’t work, you should re-evaluate your project plans.