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Risk Index Legend

Last week, PMI Group, of private mortgage insurance fame, released its “risk index” rankings for U.S. major metropolitan areas for the 4th quarter of 2007. PMI’s risk index measures the likelihood that housing prices will be lower in two years than they are now. As the map above shows, Phoenix, Las Vegas, and well, pretty much all of Florida and California were the big winners with the highest probability of declining prices over the two year period (i.e. the highest risk index). PMI’s Risk Index derives the probability by considering the amount and rate of recent historical appreciation and price volatility, housing affordability, and other local economic conditions including unemployment rates.

Does a high likelihood of price declines translate into putting the breaks on investment purchases there? I don’t think so. While price declines impact returns and the possibility or even probability needs to be considered, the risk of any real estate investment and the resulting returns will be determined by the price at which you buy your investment, not price movements in the market as a whole. For our part, we continue to keep a close eye on market rents to determine price, and we hope to find even more opportunity during the difficult markets.

If you would like to read more detailed information about PMI’s Risk Index and the areas depicted above, you can find the full report here.

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If you didn’t catch the first part of the TwoWiseAcres quick and dirty guide to taxes for the real estate investor, you might want to check it out. In the first part, I walked through reporting income and expenses for rental properties on Schedule E. In this part, I’m going to cover the basics of depreciation. I’m going to focus on calculating depreciation for the first year of a new investment purchase, but I’ll touch on depreciating capital expenditures incurred later on as well.

If you followed my advice in part one, you should now be well rested and/or liquored up. So, once again, let’s get busy.

Starting to Depreciate a Residential Rental Investment

Depreciation is essentially recovering the cost of an item (or “expensing” an item) over a number of years. To determine depreciation for tax purposes, you have to know three things: the basis, your start date for depreciation, and the depreciation period for the property.

Basis is generally cost. For a rental property, the cost includes a portion of the purchase price, expenses associated with the purchase (i.e. closing costs), and initial rehab or fix-up costs. The “portion” of the purchase price is the portion attributable to the house, and not the land. Since land is not depreciable, you’re required to divide the purchase price between the land and the building by their fair market values. There are a couple of ways to tackle this. First, you can base the allocation of the purchase price between land and building based on the assessed value for property tax purposes. For most, this means that you can go to your county auditor website which will assign a separate taxable value for the land and building and then use the percentage allocation used by the auditor to allocate your purchase price. Second, you can make your own fair market determination, as long as there’s a basis to do so. I use a standard percentage division between land and building of 20% and 80%, respectively, which I pretty much came up with from looking at assessed values to begin with. For those starting out, you’ll want to refer to the tax assessed values for your area rather than just adopt my percentage split.

Depreciating Closing Costs

For the closing costs component, you’ll probably need to refer to your Settlement Statement (or “HUD-1 Form”), but you’ll need to exclude any “pre-paids” that are typically listed as buyer’s expenses, such as pre-paid interest, property taxes, and insurance. Those items will generally be reported as expenses for the year of purchase, so they are not included in the cost basis of the property.

Depreciating Initial Rehab Costs

Fix-up costs include every expense that you incur to put the property in rent-ready condition. This is going to include items spent during the initial fix-up period that might otherwise be treated as current deductible expense items down the road. For example, your rehab will likely involve interior painting, which has to be treated as part of the basis of the property at the outset, but which would be fully deducted in the current year when you re-paint, say, at the time a tenant leaves. Why? Well, that’s what the tax code says.

Determining the Start Date for Depreciation of Rental Property

So now you’ve calculated the basis—i.e. the amount that you’re going to depreciate–now you need a start date. You start depreciating a rental property not when you buy it, but when the property is rent-ready. There’s a little bit of a judgment call here. If you buy it in January, but you’re doing a major rehab into March, then depreciation starts in March. But I almost always find that I have some punch out repairs that might even extend after the property has been rented. So, I’m generally going to pick a start date right around when I can show or advertise the property as a finished product.

For the start date, you actually just need a start month. The IRS helpfully has determined the day during the month that depreciation begins. It’s the 15th. The story goes that the IRS had originally started drafting a complicated set of rules to narrow the start date right down to the day, but got tired and ended up with the 15th, collectively reasoning “close enough.” Now, I could use some fancy IRS terminology like “mid-month convention”, but I’m going to just repeat—it’s the 15th. So if you finish your rehab on March 2, you’re depreciation start date is March 15. Close enough.

Determining the Depreciation or Cost Recovery Period for Rental Property

The last piece in the depreciation puzzle is the depreciation period (or “cost recovery” period in IRS parlance). Here’s where the IRS starts with its explanation:

MACRS consists of two systems that determine how you depreciate your property—the General Depreciation System (GDS) and the Alternative Depreciation System (ADS).

Since the whole purpose of this article is specifically not to use terms like “Modified Accelerated Cost Recovery System,” I’ll just cut to the chase. For the most part, two periods will be applicable to about any depreciable property for residential real estate investing. The first is the depreciation period for the house itself. It’s 27.5 years. This depreciation period also applies to about any major depreciable item that you attach to the house—such as a roof, a major kitchen remodel, window replacement, etc. Then there’s the period that applies to about anything that you put in the house. It’s 5 years. This applies to things like kitchen appliances, carpet, and furniture.

The Depreciation Calculation—the Straight Line Method

Now we have all of the necessary information to do the math. For most, depreciation will be calculated using the straight-line method—which means the depreciation deduction for each full year of depreciation period will be the same. To calculate a year’s depreciation, you divide the cost by the depreciation period. For the year that you start depreciating (as well as the last, when you sell it), you’ll be calculating depreciation based on the partial year. Let’s take our example of the property that was ready for rental on March 2 and assume that the cost including rehab is $100,000.

The annual depreciation amount is $100,000 divided by the depreciation period of 27.5 years which equals $3636.36. For the first partial year, the depreciation amount is calculated for 8 full months plus ½ month for March (if you didn’t catch it before—our start date is the 15th). The calculation is 8.5 months divided by 12 months times the annual depreciation of $3636.36 which equals $2575.76. If you bought some appliances for the home, the calculation is essentially the same but using a 5 year period to determine the annual depreciation.

The depreciation deduction for subsequent years, until the year of sale, will be the annual depreciation amount each year. In the year of sale, the partial year’s depreciation calculation will be the same as the first year’s. That is, you’ll figure the partial year’s depreciation up until the date of sale, but will treat the sale as occurring on the 15th day of the month in which the property was sold. Again, close enough.

Depreciating Capital Expenditures for Rental Property

If you incur a capital expenditure after the year of purchase, such as replacing a roof, the expenditure will be depreciated as a separate item. In other words, for tax reporting purposes, you’ll separately depreciate the roof over a 27.5 year period, calculating depreciation in the same way as you calculated depreciation of the home itself, including using a start date of the 15th day of the month in which the roof was installed.

As a final note, I’ll point out that there are alternatives to using a straight line method of depreciation and alternatives to using the depreciation periods referenced above. Different rules may also apply to property purchased prior to 1986. But this, my friends, is where I hop off the train. If you need more information on depreciation or alternatives available, a tax advisor may be in order. In the meantime, I’ll just wish you all a happy tax freedom day, which I believe falls somewhere in late April these days. Here’s hoping that taking advantage of some depreciation deductions will move it a bit earlier.

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It’s tax time once again. And if you’re a real estate investor and you’re anything like me, it is about this time every year when you contemplate switching your investment portfolio to something like a savings account. Granted, savings accounts return about 1.5% per year, but at least you don’t have to fill out another Schedule E. Well, to attempt to help remove some of the pain for my fellow investors, I decided to put together the TwoWiseAcres quick and dirty guide to taxes for the real estate investor. I’m going to quickly cover the basics, but will be so bold as to run through some rules for calculating depreciation deductions.

Let’s all just keep one thing in mind at the outset. I will warrant this information only to the extent of Rob’s contribution to the process of calculating our taxes on the TWA investments. This, as you can imagine, is the most limited of the limited warranties. I will say, however, that this article generally covers the process that I follow in preparing my return, and I’m still a free man. So, with that said, let’s get busy.

Reporting Taxable Income from Residential Real Estate

For the beginners, if you haven’t figured this one out yet, taxable income and loss for residential real estate is reported on Schedule E. If you are using any form of accounting software to track your income and expenses, it’s probably a good idea to set up your accounts (either “chart of accounts” or “categories” or whatever terminology your software uses) to pattern the income and expense categories of Schedule E.

As a real estate investor, your primary income will be from rents. But you may also have other income, such as application fees, late fees, and what have you. For Schedule E tax purposes, you only have two choices for reporting all income—“Rents Received” and “Royalties Received”. Unless you are a songwriter, as well as real estate investor, in all probability, you can ignore the “Royalties Received” part. (If you haven’t guessed, Schedule E isn’t just for real estate investor types). So, all rents and fees paid by tenants will be reported as “Rents Received.” For software tracking purposes, consider setting up subaccounts under a primary “Rents” account to the extent that you want to separately track other specific fee items.

Reporting Taxable Expenses from Residential Real Estate

Most of the Schedule E expense categories are relatively self-explanatory, and many follow how you would probably track your expenses in any event. For example, Schedule E expense categories include advertising, insurance, utilities, and legal and professional fees. However, a few categories deserve a little explanation. For example, two of the Schedule E expense categories are “Cleaning and Maintenance” and “Repairs”. So, when you send the handyman out to fix the handle on the toilet so it stops running in perpetuity, have you just incurred a “maintenance” cost or a “repair” cost. My simple answer: Who cares? The effect on your taxable income or loss is the same regardless of which category you use, so let’s not get too hung up here. As a rule of thumb, I’ll categorize items like lawn care, painting, cleaning, and the like as maintenance and expenditures to fix the thing that isn’t working as a repair and most importantly not spend more than 10 seconds to debate the difference.

Schedule E expenses, of course, include a line item for mortgage interest. The interest portion of your mortgage payment is deductible. The principal portion is not. Since I’m generally more interested in tracking cash flow for my properties on a monthly basis, I will track my mortgage payment (both principal and interest) as an expense. This allows me to run a profit and loss report that is really reporting my cash flow. In short, this method is both a software “workaround” and a reflection of the fact that I don’t want to manually enter a mortgage payment each month that breaks down principal and interest. So, I have to do some year-end adjustments for tax purposes. Since mortgage lenders are required to issue Form 1098s to you, as borrower, that show the interest paid for the calendar year, the adjustment is a relatively simple one. Use the amount reported on Form 1098 to report Schedule E mortgage interest. (But periodically check the bank’s reporting of interest against your own amortization schedule. They do, in fact, make mistakes from time to time.)

Schedules E includes categories for “taxes” and “insurance”. For the real estate investor, the taxes category means property taxes. Insurance includes property insurance and mortgage insurance (if your loan required mortgage insurance). Pretty straightforward, but there are a couple of things to keep in mind here. If your mortgage loan requires that you pay taxes and insurance into escrow, the amounts you pay into escrow may not (and, in fact, probably won’t) reflect your actual expenses for these items. Banks set up escrow accounts to make sure these items get paid. The mysterious calculations that the banks use to calculate your contribution to this escrow account are designed to insure that the bank has enough of your money the cover the costs as they arise. What will never ever ever happen is the bank advancing these expenses because there wasn’t enough in your escrow account to cover the costs. That means that there will always be more than enough in the escrow account to cover anticipated costs. Your expenses, for tax purposes, are the actual expenses paid by the bank from the escrow account. For property taxes, you can again refer to Form 1098. Mortgage lenders maintaining an escrow are required, as with mortgage interest, to report property taxes paid on your behalf for the year on this form. As with mortgage interest, the occasional check against the county auditor’s records (mostly available online) wouldn’t hurt.

Insurance is a bit different. Form 1098 includes mortgage insurance; it doesn’t include property insurance. So, you need to know what your mortgage lender paid from the escrow account for property insurance during the calendar year. Most larger mortgage lenders provide online access to reports of escrow activity during the year. (They also should have sent you a statement of escrow activity that will show this expense). Otherwise, you may have to thumb through your monthly mortgage statement to extract the information. Typically, property insurance is paid in one annual premium, so it shouldn’t be that difficult to find if you haven’t tracked it during the year.

Finally, Schedule E includes a category for “other” expenses. My advice—track your expenses as “other” expenses sparingly. You’re going to have to include an itemized list for this category for the IRS’ amusement and edification. So, it’s best not to use other as a casual default category. I will typically have costs such as credit reports, lockboxes, and the like here.

So there you go. You now have your Schedule E Income and your Schedule E Expenses. The result is your net income before depreciation, or in Schedule E terms, your “add lines 5 through 18”. Calculating depreciation is always just a bit—how shall I put this?—maddening. So, let’s all take a break, grab a short nap, perhaps a beer, and then return for the next part on calculating depreciation.

In the meantime, if you still have questions on the income and expense side of Schedule E, here’s a handy IRS publication for your reference. It might just answer a couple of questions that I haven’t covered, but I warn you, it’s not for the feint of heart.

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Here’s in interesting chart from the NYT showing the impact subprime mortgages have had on foreclosure rates. In the mid-west where Mike and I buy properties, there have been lots of foreclosures, but their connection to subprime mortgages is less than clear. In fact, some of our best foreclosure deals were made before the subprime mess erupted. The NYT’s article is worth a quick read. And you can click here for a bigger view of the graph.

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I was first introduced to high dynamic range (HDR) photography about a month ago as I was searching for some photos to include in my personal finance blog. I came across some HDR photos on flickr, and at first wasn’t quite sure what I was looking at. Lately, HDR photos are about all I use anymore because the pictures are simply stunning. So yesterday I noted with interest an article about the use of HDR photos in real estate marketing.

These vivid HDR photographs can be taken with a DSLR camera, but do require software such as Photoshop to process the image. Here are some nice shots I found on Flickr that will give you an idea of what an HDR photograph of a home would look like.

hdr-house-2.jpg
Photo Credit: chefranden

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Photo Credit: Chad Jones of Gold Coast Real Tours

hdr-house-3.jpg
Photo Credit: salendron

I included the last picture both because it’s such an unusual shot and also to show you that HDR photographs can get a bit weird. Done right, HDR photographs may be a great way to showcase your real estate offerings, but you’ll need to make sure the tones in the image don’t get too spooky.

Note, the first photograph in this article is courtesy of CodyR.

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According to a Wall Street Journal article published today, a wave of foreclosures is starting to drive down prices as banks put more properties on the market. In some areas, foreclosure-related sales account for 40% of all sales. Well a few weeks ago Mike and I did our own sort of investigative reporting–we went house hunting. In later articles we’ll show you some pictures of the dumps we looked at, but for today, suffice it to say that there were some deals out there, but no steals.

When Mike and I started investing together in 2005, we were able to buy homes (including rehab costs) for about 80% of value. Today, in the same area with plenty of foreclosures, it’s about the same. If you really hunt down a great deal, you might be closer to 70% of value, but the banks aren’t giving these properties away. And when you do find a great deal, there’s almost always a lot of work to do. Take for example one peach of property we looked at that I’ll call Dead Man’s Den or DMD for short.

DMD is a four bedroom two bath cape with a detached super-sized garage on about .2 acres in middle-class America. I call it Dead Man’s Den because there was a painted outline of a body on the family room carpet (no, I’m not joking). Every surface in this house was soiled, trashed, written on, punched through or missing. The smell was difficult to identify, but let’s just say we were breathing through our mouths. The kitchen and baths need gutted to the studs. And the detached garage had fire damage. Whether it could be saved or not was unclear.

The bank was asking $48,000 for DMD (note, I don’t think the bank referred to the property as Dead Man’s Den, but I’m not sure). We guessed repairs would cost at least $30,000, but with the garage, it could go a lot higher. In addition, there were undoubtedly busted water pipes through out the house in unknown locations. So we’ll put the total cost at somewhere between $80,000 and $90,000, and that’s after a major, time consuming rehab. And the value of the home fixed up is about $110,000. So there you have a deal, but certainly not a steal.

We offered $40,000 and were out bid by one or more offers at the asking price. I don’t regret not winning the bid, other than it sure would have been fun to blog about a rental property we could legitimately call Dead Man’s Den. I’ll leave you with this chart showing the 10 metropolitan area with the most foreclosures:

cities-with-most-foreclosed-properties.gif

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House in a Box–Fact or Fiction

Have I got a deal for you. It’s called “House in a Box” and it is exactly what you hope it’s not–a house in a box. They can be shipped right to your location for “easy” assembly and installation. Talk about a great investment. Where else can you buy a 1,150 square foot home for just $36,000 via mail order? If you are the ultimate do-it-yourselfer, a kit house may be just the thing.

One hundred years ago, Sears, Roebuck & Co. began selling the first mail-order, pre-fab homes. From 1908 to 1940 Sears sold some 75,000 mail-order homes. With 447 different styles, these homes ranged from the multi-story Ivanhoe series to the more sedate Goldenrod, a 3-room no bath affair. Well, the Sears mail-order home is enjoying something of a renaissance.

Here are a few modern day options if a House in a Box appeals to you:

Rocio Romero

Rocio Romero is the owner and principal of Rocio Romero, LLC. Rocio received her Masters of Architecture from Southern California Institute of Architecture and her Bachelor of Arts Degree in Environmental Design with a major in Architecture from UC Berkeley. At Rocio Romero, LLC, they design, manufacture, build, ship, and sell kit homes. Their flagship home is the LV series, which Romero has sold more than 150 since launching the product in 2003.

Here is what one of her model homes looks like:

rocio-romero-lv-home.png

Flatpak

Flatpak offers an interesting alternative, even in the mail-order home business. Homes are designed from the ground up much like my son builds homes with his legos. They don’t have standard prices, but estimate that their homes cost between $200 and $300 per square foot. I guess they don’t sell an economy model. Flatpak also has the strangest website I’ve seen in some time. But the cool part is that they’ve put pictures of their homes on Flickr.

Here’s one of the pictures you’ll find on Flickr (and the snowplow is not included in the purchase price):

flatpak-house.jpg

Nexthouse

Empyrean International has designed and built kit homes for years. The “Nexthouse” is the newest model for a company who’s service mark is “sustainable home building systems.” They describe Nexthouse as having been

designed around a central clear-spanned living, kitchen and dining volume that opens onto a large outdoor living space through the use of a 24-foot accordion door, which is suspended from a gallery space above that also houses an automated insect screen. When lowered, this screen allows the entire main volume of the house to function as a screened room, providing a new dimension to living and encouraging passive whole-house ventilation. Built almost exclusively with wood, NextHouse brings warmth to modern design and provides a clear relationship of interior to exterior.

In other words, if you’d like to live in a screened-in porch, Nexthouse is for you. In all seriousness, the home actually looks rather nice and boasts 5,000 square feet:

nexthouse.jpg

Cost

As a final note, we should add that these homes aren’t all inexpensive. While Rocio Romero has a model starting at $36,000, that doesn’t include the land, permits, construction and various interior items. And one couple who recently bought the Nexthouse spent in total $800,000 for the 3,000 square foot version of the home.

I think Mike and I will wait for the first Nexthouse foreclosure before considering an investment.

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This is the third and final article in our series on how to remodel a kitchen for under $4,000. In the first article, we described the factors we consider in deciding whether we undertake a major kitchen overhaul. In the second article we described how we design the remodel and select the materials. In this article, we will describe how we pick a contractor, show you the detail of our costs, show you pictures of the kitchen, and suggest a couple of easy, low-cost ways to set your property apart from the competition. Oh, and we’re going to reveal why this series should have been called “How to Remodel a Kitchen for Under $4,307.” In anticipation of this last point let me assure you that it’s all Mike’s fault.

How to pick a kitchen contractor

The easiest way to pick a kitchen contractor is to know how NOT to pick a kitchen contractor. Don’t hire a company that specializes in kitchens. They may do great work, but they cost an arm and a leg. I know, having just finished a major kitchen remodel in my own home. And don’t pull out the yellow pages. Your contractor isn’t there either. You want to pay for the remodel, not the box ad in the phone book or the 800 number.

We hire individuals (not companies) who have basic carpentry, plumbing, and electrical skills. And we hire them to handle most of the repairs to the home, not just the kitchen. This helps in getting the best price possible.

Personal referrals are always the best place to start. Nearly everyone knows someone who knows a guy that works for the yellow pages company but does handyman work on the side. Granted, a kitchen remodel is no small task, but a structural engineer is probably a little overkill. So, if you find someone with some skills, a personal referral, and maybe a prior job that the someone has done and you’re most of the way there.

With hiring individuals, we don’t rely on them for every task that we might expect from the yellow pages company. We do the layout and design part and pick the materials. This not only saves on labor costs, it also avoids some unpredictable (and frequently less desirable) materials choices.

After a while, you’ll develop relationships with contractors that you feel comfortable relying on. These contractors typically work one job at a time, so you get their nearly undivided attention until the job is done. In the case of No Basement, the cost of the contractor’s labor for the kitchen was $1,000.

Total Costs

Here are the total costs for the project:

Appliances $1,468
Cabinets/Counter $1,423
Faucet $44
Ceiling Fan $36
Labor $1,000
Vinyl Floor $186
Total $4,307

In my opinion, the kitchen rehab increased the value of the home by at least $10,000. Not a bad return on investment.

Pictures of the Kitchen

I know this is the moment you’ve all been waiting for. Well, here you go. Pictures of a kitchen that almost cost under $4,000:

uglykitchen.jpgPhoto Credit: mahmut

Wait a minute. That’s a picture of Mike’s kitchen. Sorry about that. Here’s our $4,000+ kitchen:

kitchen1.jpg


kitchen2.jpg

Ways To Make Your Investment Stand Out

Kitchens are where you get the bang for the buck, so consider spending a couple more than you have to. Here are three easy, inexpensive ways to do it. First, upgrade the standard builder-grade faucet. A recognized brand high-arc faucet can cost as little as $20 over the one that you see in every new-build starter, yet it makes the kitchen stand out. Second, while granite might break the budget, ditch the pre-formed off the shelf counter. Instead, find a supplier that sells the laminate counter top materials and have your carpenter build it. The laminate finishes come in far more varieties than the off the shelf counters. Also, since virtually no wall of a frame home is ever a straight line, installation of two-piece counter/backsplash is typically easier. Finally, upgrade the lighting. Again, the cost difference is minimal but adds much to the visual picture.

I have to admit that Mike did a great job on this rehab, even if he did blow our $4,000 kitchen budget by an eye-popping $307. We’ve been looking to buy another rental property, so Mike will likely get a second chance at actually bringing a rehab in under budget.

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One of the many things that amazed me about the management side of real estate investing was the "No Show."  The No Show is the prospective tenant who calls to say they drove by the house, love it, and would like to sign a lease right away.  You make arrangements to show them the house, confirm the appointment 1 hour before the allotted time, and then they don’t show up or even call.  This happens over and over and over again.  It’s still a mystery to me why that don’t exercise the common courtesy to call us to cancel the appointment.  So we’ve come up with a way to address this issue, at least in part.  I’ll explain what we do in a minute, but first, here are some other types of prospective tenants we’ve encountered over the years.

The Negotiator:  "I see you’ve listed the rent at $1,295 a month.  Would you accept $800?"

The Credit Risk:  "I recently filed for bankruptcy protection.  I’ve also been evicted from my last 7 rental units.  Will that be a problem?"

The Out-of-Towner:  "I am moving to your area and will be in town Saturday to look at homes.  Can you show me the property that afternoon at precisely 2 pm?"

The Anxious:  "I’m very interested in the property and must move by the end of the week.  Can I see the property today?"  These prospective tenants almost without exception become No Shows.

The Planner:  "I see the property is available April 1.  I need a place beginning in July.  Do you think your property will still be available?"  God, I hope not.

The Cash Cow:  "Can I pay $15,000 up front to lower my monthly rent?"  While always exciting, these folks never work out.  And if a tenant is paying you in bricks of cash, you may wish they had become a No Show.

The Scam Artist:  Contact is always made via email:  "I’m from the UK and will be moving to [insert any mid-sized town in Podunk, U.S.A.] at the end of the month.  I’m very interested in the property you’ve advertised.  I can pay with a money order, and would like to write it for 5 times the actual rent.  Please send me the balance in cash as I’ll need it for moving expenses."

The Murderer:  One of our prospective tenants was a convicted murderer.  I let Mike call him to reject his application.

The Story Teller:  "So any way, my husband lost his job two years ago, and we’ve been running an eBay store to get by.  If you’re ever looking for handmade booties for your cat, you’ve come to the right place."

The Dreamer:  "We won’t rent for ever.  Our plan is to build a 10,000 square foot home next year once we get our credit cards paid off."

Well, you get the idea.  So back to the No Show.  What Mike and I did this past week was to hold an open house for our property, The Problem Child.  As prospective tenants called or emailed us about the property, we told them about the open house.  Some wanted to see the property at a different time, but we declined.  Part of that was due to the fact that the property is still occupied.  But regardless, we gave them a 2-hour window on a Saturday afternoon to see the property.  If one or two didn’t show, so be it.

In terms of traffic, the open house was a success.  We had several couples come by to see the property.  And it sure beats driving out to the property for one prospective tenant who fails to show.

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In the previous article in this series, I looked at factors to consider when deciding whether and to what extent a real estate investor should remodel a kitchen. With our property, No Basement, Mike and I decided to completely renovate the kitchen using a budget of just $4,000. In this article, I’ll be writing about the next step: design and materials selection.

Designing an Inexpensive Kitchen Remodel

It is in the design phase that many investors go wrong. The wrong design decisions can quickly add thousands of dollars to a project both in material and labor costs. They can also delay the rehab process if they add additional inspection requirements to the project. So we follow some basic rules of thumb when designing a new kitchen:

Rule #1: Never move a load-bearing wall unless there is no other option. To this I should add Rule #1.5—there is almost always another option. Moving load bearing walls, and particularly exterior walls, require the services of an engineer during the design phase and additional inspections by your local government. Professional fees, inspections, and construction costs to move a load-bearing wall could break the bank and delay the project by weeks, if not months. On a $4,000 budget, it’s not an option.

Rule #2: Stick to the original kitchen layout as much as reasonably possible. This is not the time to be creative. If the original kitchen layout works reasonably well, keep it. Any substantial redesign in the layout will almost certainly mean re-routing plumbing and electrical. Keeping the existing layout will save time during the design phase and will reduce complexity and costs of the project.

Rule #3
: Use as much of the existing kitchen as you can. In No Basement, Mike and I considered keeping the original floor. In the end, we replaced it, but it was a close call. If you can design the new kitchen in a way that allows you to keep parts of the old kitchen, you can save even more money.

Rule #4: Improve functionality in the cabinet configuration. While the overall kitchen layout will likely stay the same, there’s always some room to change the cabinet configuration. We’ve seen numerous builder designs and bad remodels that don’t make sensible use of the existing space. Home-improvement retailers typically offer free design assistance. You’ll need the kitchen measurements and a quick crash course on standard cabinet sizes, but then you can change up the cabinet configuration pretty easily. Here are a couple of quick ideas. Make sure there’s a drawer set. Builders somehow manage to skip this on homes with some regularity. Change out a blind corner to an easier access lazy-susan. Consider a tall pantry cabinet when the kitchen doesn’t have a closet-style pantry built in. And here’s one we used for No Basement. The kitchen is an L-shape, which generally means a dead space at the corner. We flipped the direction of a cabinet at the corner to add some extra storage and used a wider counter-top that created a breakfast bar. Kitchens sell. A more functional cabinet configuration within the existing layout will help bring buyers and keep tenants.

Picking Inexpensive Yet Durable Materials

Once you’ve chosen the layout of your new kitchen, selecting the right materials is critical to staying within your budget. The four major costs to most kitchen remodels are cabinets, appliances, flooring and labor. We’ll leave the labor part for now, but here’s how we choose the materials.

Cabinets: When Mike and I tackled the first kitchen remodel, I was totally unaware of how inexpensive good quality cabinets can be. We buy pre-finished, stock cabinets, typically from Lowe’s. These cabinets come off the shelf, ready for installation by our contractor. We have a commercial 30-day account at Lowe’s that gives us a 10% discount on most purchases, including cabinets and about everything else we’ll need in the kitchen. The cabinets look good, are durable, and inexpensive.

Appliances: We provide appliances in all of our rental units. It seems odd to me that somebody would rent a single family home without appliances, but I know landlords who still don’t provide them. The market dictates the rule here. In our area, renters of single-family homes sometimes furnish their own refrigerator and stove, but the market is trending towards all kitchen appliances coming with the home. If you really want to “design on a dime,” 86 the fridge and stove, and offer to provide them as an option, with an additional rent charge. As a built-in appliance, a dishwasher is pretty much standard either way, but also the least expensive of the set. We provide a full appliance set in all of our homes with the idea that it completes the overall visual picture and helps bring the renters, and higher rents, that much quicker.

We buy our appliances from a local discount appliance store. (Even with the discount, Lowe’s doesn’t always hit the price point on appliances). We’re happy with the floor model if it’s in good shape, and it saves us even more money. We still stick with the recognized brands, and we’re looking to beat builder grade. For No Basement we bought stainless appliances for just a few extra bucks over the standard plain-jane white.

Flooring: Here we splurged and imported marble tiles from Italy. Well that was my idea, but Mike chose instead to import some vinyl flooring from a local flooring store. He has no imagination. But it turns out that he can pick some of the finest linoleum in the tri-state area. The flooring tends toward the neutral, but is a cut above builder grade and actually looks good. Ceramic tile is an option. It may win on durability but probably not, even in the long-run, on cost.

In the third and final article, I’ll discuss how we select a contractor, sum up the costs of the project, and suggest a few inexpensive ways to set the kitchen apart from the competition. I’ll also show you some pictures of the finished product at No Basement. Until then, if you’ve renovated a kitchen, drop us a comment about your project. Better still, send in some pictures, and we’ll include them in the next article.

Photo Credit: onebyjude

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