Should I Consider a Fixer Upper?

To buy a house that's a fixer upper can certainly be a rewarding opportunity, but one must be wary.

A common cliche claims the most important 3 things about real estate are..

Location ... Location ... Location

It's kind of obvious, but it's important.

Personally, I'd prefer to buy a fixer upper in a great area over a beautiful home in an undesirable neighbourhood. You can live in either, but from an investment perspective, you're far better off in the great area ... and improve the house value.

This is called the ...

Principle of Regression and Progression.

It basically states that a home market value is affected, positively or negatively, by the property values of other homes in the immediate neighbourhood. Regression is the decrease in house value when the surrounding homes are smaller or inferior in some way. Progression is the increase when the surrounding homes are superior to the subject property.

So, if you buy a fixer upper on a prime lot in a prestigious neighbourhood, it would be difficult to over-improve it by spending too much of your hard-earned money on it. You might even be able to justify demolishing it to build a larger home to match the stature of the neighbouring houses, and still have a good investment.

In the less desirable neighbourhood, it would be easy to over-improve the property. And when you buy a house and renovate it so it looks great, you can't just lift it up and move it to a better location.

Buying a luxury home in a rough neighbourhood would not be a great investment, unless you plan to be Lord of the Manor in your own fiefdom.

While we're on the topic, here's another evaluation principle called the ...

Principle of Substitution.

It refers to the actual value of an amenity, or feature, of the property. Value is not determined by the cost investment in a property, but the value derived from it. For example, you could have two identical homes, side by side. They're exactly the same, except that one home owner had to spend twice as much to create a well because his home was situated on solid granite, and the neighbour's home is on clay. The market value for these two homes would be the same because the value is based upon the water produced - not the cost of obtaining it.

So, Where Should You Buy?

Where the advantage comes into play is if you buy a house, a fixer upper, for the right price, relative to its location and general physical condition. If you're a novice when it comes to renovation and construction, it would be wise to have a trusted contractor accompany you on the inspection. This way, you'll have some idea of the cost to renovate the fixer upper, and whether or not you can make a prudent investment.

Another consideration is whether or not you plan to live in the house during the renovation. Obviously, it's not exactly a great experience living with construction going on every day and all that entails.

And they don't call it 'divorce dust' for no reason.

Many a buyer has optimistically and joyfully bought a fixer upper house in rough condition, thinking they could do a quick, easy reno and 'flip' it for a profit, only to be surprised that at the end of the day, there was no profit to be had. Hmmm.

Besides the actual cost of materials, labour and building permit fees, you'll need to factor in carrying costs for the mortgage, taxes and utilities during the renovation period.

How Long Will You Own It?

And don't forget legal fees and disbursements and land transfer tax, and the same on the sale except for the tax. Also, you'll have real estate commissions to re-sell it.

If you intend to advertise it for rent or sale, you still have to carry it until closing or possession by your new tenant. And pray that you'll get a tenant who'll respect your property and pay the rent on time.

If you plan to keep it, either for your personal residence or to lease, then depending on market conditions, you might be successful. Even if you must spend more than expected, in the long term, you'll likely be Ok because, typically, real estate prices go in one direction - up.

And don't forget the tax man. Unless it becomes your principle residence, you may have to pay capital gains tax on the net profit - if there is any, that is - when you eventually sell it.

If you're considering a fixer upper, think twice before you leap.

Click this link for more information from CMHC on tax credits which might help you decide whether to buy and renovate that fixer upper.

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