Should I Consider a Fixer Upper?

To buy a house that's a fixer upper can certainly be a rewarding opportunity, but a prudent would-be investor should exercise caution and undertake due diligence before leaping. A common cliche states that the most important 3 things about real estate are..

Location ... Location ... Location

It's kind of obvious, but it's really important. Personally, I'd prefer to buy a handyman special in a great area over a potentially beautiful home in a less desirable run-down 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 involves the ...

Principle of Regression and Progression

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

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 justify demolishing it to build a larger home in line with 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 move it to a better location.(Well, I suppose you could, but it would be hugely expensive, hence impractical.)

Buying a luxury home (or one with potential) in a rough neighbourhood would be an unwise investment unless you plan to be Lord of the Manor in your own fiefdom.

Principle of Substitution

This evaluation principle 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 by the value derived from it. For example, take two identical homes, side by side. They're exactly the same except one homeowner had to spend twice as much to create a well because his home was situated on solid granite and the neighbour's home on clay. The market value for these two homes would be the same because the value is based on the water produced and not the cost of obtaining it.

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Where Should You Buy a Fixer Upper?

Where the advantage comes into play is if you buy a fixer upper for the right price relative to its location and general physical condition. If you're a novice renovator, invite a trusted contractor to accompany you on the inspection. This way, you'll have some idea of the cost to renovate the fixer upper and whether it would be a prudent investment.

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

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 reno and 'flip' it for a profit, only to be surprised on completion of the project when they discover that they generated no profit, maybe even a loss. Hmmm.

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

How Long Will You Own It?

Don't forget legal fees, disbursements and land transfer tax(es) 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 you get a tenant who respects your property and pays the rent on time.

If you plan to keep it, either for a personal residence or to lease - and you bought smart - depending on market conditions, you might be successful. Even if you spend more than expected, in the long term, you'll likely be okay 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 - when you eventually sell it. Further, if you do this regularly, you must declare the net profit on your annual tax return.

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

Visit CMHC for information regarding home renovation financing options. Perusing their site, particularly the Green Renovation Guide, might help you decide whether to buy and renovate that fixer upper.

If you're interested in learning more about buying an investment property, check out my book The Happy Agent. An entire chapter is devoted to the subject. Learn about return on investment, effective planning, short and long term investments, various principles involved and more. It's chock full of knowledge accumulated during my successful 40-year career in the business.

When you consider the huge amount of money involved in realty acquisition and its associated risk, a small investment of your time and a pittance of your money could save you thousands of dollars and a lot of heart-ache. Learn how to trade in real estate like a pro.

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