K and I recently bought an investment property to house hack. This is the 3rd post of a new series on strategy and tactics for how to house hack in an expensive market, using our own example as a case study. Check out all the posts in this series:
- House Hacking San Francisco Bay Area style (how we’re creating real estate wealth by having others pay our mortgage on a multi-million dollar house)
- How to research real estate markets (the single best resource you need)
- You are here: How to do a residential property inspection step by step (what smart real estate investors look for)
- (Further posts forthcoming)
Last time, I walked through the checklist I use to due diligence a property in a crazy competitive market.
For the 4-plex we bought, K and I did as much legwork as possible before actually viewing the property. But once we were confident enough things looked good, it was time to get off our butts and go see it in person.
And there’s no way around that.
Unless you’re willing to buy sight unseen, you HAVE to see the property in person. Now, that’s not a problem if the unit is close by and you’re only going to showings occasionally. But it sucks if you have to drive far away and you’re doing multiple showings a week.
Even worse: doing all that work but then losing the offers you write!
You’re coordinating back and forth with an agent. Taking precious time out of your day. Putting on your pants and jacket and slogging through 45 min or 2 hours of traffic. Sometimes in the rain. Maybe even wrangling your contractor to go with you (more coordination) to start estimating rehab costs. Doing this multiple times a week. And then, after giving sellers your thoughtfully written offer, getting blown away by some cash buyer.
How can you minimize this pain and frustration?
You probably can’t avoid property showings altogether, but you can definitely optimize them and maximize efficient use of time.
Today I’ll share a low effort strategy for making property visits MUCH more efficient, plus tips for methodically doing an inspection – exactly what to look for, and how to judge whether something is a deal-breaker or not.
I’ll also share insight on how you might think about repositioning a property to add value and make it a magnet for desirable tenants and high rents.
If you can, write cancellable offers first (sight unseen)
If you can write a compelling offer with a contingency (30 min), then I actually recommend doing that first. BEFORE you actually go view the house. The contingency should be long enough for you to do reasonable inspections and back out if necessary. Do this on a lot of properties you think you might be interested in.
Writing a lot of offers and then only viewing those properties that accept your offer will save you a TON of time. You focus only on properties that are realistic to close, plus you don’t waste time getting emotionally attached to anything (never a good thing when dealing with big money).
But wait a minute, how can you be sure what price to write?
Sometimes the inspection itself is crucial to forming a price opinion, right? Sort of. If you’re wearing an objective investor hat, you can actually get just about all the info you need to come up with a fair price by analyzing recent comps (for 4 units or less).
For 5+ unit buildings, see if you can obtain the rent rolls from the listing agent to calculate net operating income (NOI) and compute valuation based on local cap rates. (Read my previous post if you need a refresher on the math formulas, or use my free spreadsheet tool.)
If you’re afraid of overpaying because you’re worried you’ll discover an unpleasant surprise once you actually get inside the property to inspect, you can always offer less than list price (within reason). And you can follow up with the listing agent to feel out how many offers they have, and how fast they’re coming in.
Make your contingency subject to inspecting the property after your offer is accepted. But don’t broadcast that your offer price may decrease if you find the condition inside is bad. The seller may think you planned all along to offer high, and then pull the rug out on the price once you were in contract.
To be sure, if you DO find the condition inside is significantly worse than you were led to believe, it’s fair to propose a price reduction before backing out. Often the seller won’t agree. But sometimes they will. You never know. Just don’t play games and always act in good faith and you’ll be fine.
But hold on, you say: what if you live in a super competitive market?
In the San Francisco Bay Area, where I live, having any kind of contingency is a VERY big disadvantage. Your offer becomes far less competitive. Realistically, in markets like mine, you have to do all your homework beforehand (hence the urgent time constraints I described in my last post). K and I bid on a lot of places and we lost a lot; it seemed like we mostly lost to no-contingency offers.
If you’re in this situation, unfortunately there isn’t an easy hack.
So if your market is crushingly competitive, like the Bay Area, where adding a contingency is a big drawback, you’ll have to try to view the house first and do as much diligence as possible beforehand.
That’s what we had to do. Whenever a new place we liked got listed, I hustled relentlessly day in and day out until that property was no longer on the market. Most of the time we lost. Until finally, one day, our offer got accepted. Great feeling.
Checklist: How to do a property inspection (what smart investors look for)
If you can write a cancellable offer first, I recommend doing so before spending time to view the property. But if you can’t due to your market’s competitiveness, then you’ll have to view the property first. A solid property inspection should take about 1-2 hours.
What should you look for in a property visit? Two things.
- Material defects that could be deal-breakers
- How to potentially reposition the property to increase its value
When it comes to deal-breakers, the basic idea is this: focus only on material items that impact either structural integrity of the building or marketability of the property.
Do not nitpick over cosmetic flaws, minor damages or imperfections that are inexpensive to fix, old fixtures/appliances, etc. Bad-looking properties are usually good investments because many buyers either don’t understand them or are too lazy to deal with them. The best investments are bad-looking properties that have, additionally, been poorly marketed (i.e., bad listing agent).
In general, I strongly recommend looking past stuff like:
- Peeling paint or gaudy wall colors
- Dingy carpets
- Holes in walls, damaged doors/frames
- Damaged blinds
- Outdated/broken light fixtures
- Old cabinetry (as long as it’s still structurally sound)
- Missing or damaged closet shelves/racks
- Broken mirrors
- Shabby toilets and mildewy shower tubs (unless there is a water leak problem)
- Old/broken/missing appliances (easily replaceable and can be inexpensive)
- Sun-damaged exterior wood panels, cracking stucco
This stuff is easy and inexpensive to fix, even though it’s gross to look at.
Then there’s stuff that I’m personally OK with, but some other folks reasonably may not be:
- Broken windows
- Moderately damaged hardwood floors (more than nicks and dings)
- Moderately damaged cabinetry
- Visibly leaky sinks
- Leaky toilets
- Broken flooring tiles
- Water-damaged sheetrock or subfloor
- Leaky roof
- Broken water heater/furnace
I should say, I’m OK with the above as long as it’s properly adjusted into the price. I’m willing to do the work to fix it up, but there must be a commensurate reduction in price to account for both the actual damage itself plus a return on my time for fixing it.
I tend to especially like properties with crappy kitchens (damaged cabinetry, flooring tiles, outdated lighting, broken appliances), because a nice updated kitchen probably has the greatest impact adding value to the property, and there are some very cost effective ways to update a kitchen.
A busy renter (or buyer for that matter) with money but no time – your target customer – often prefers not to deal with the hassle of having a crappy kitchen or updating it themselves and is often willing to pay a premium to have the kitchen be move-in ready. That’s true regardless of whether they actually plan to cook in the kitchen!
So if you can provide that to them, you’re instantly adding value they’ll happily pay for in return. I guess there’s just something about having a nice kitchen that makes the entire property more attractive, even if you never intend to cook in it.
Finally, there’s stuff you should look for that could be deal-breakers because they affect structural integrity or marketability of the property.
There are only 3 categories I tend to pay attention to, and even then they must be major problems for me to reconsider purchasing:
- Foundation problems
- Water problems
- Termite problems
Even these 3 categories are fixable because, ultimately, everything is fixable. It’s just that these categories can get VERY expensive to fix if you don’t buy at enough of a discount.
But as long as the seller is willing to credit you enough of a discount to compensate for even major structural damages (including a return on your time for fixing them, plus extra cushion to account for uncertainty), then it may STILL be worth buying the property. Everything is doable if it’s factored into the price…but just remember the price can’t go below zero and most sellers have a minimum (above zero) they’re willing to accept.
So these 3 categories CAN become deal-breakers if their repair cost + the original purchase price you pay ends up exceeding the value of the property, i.e., the value you can get by selling it.
And the problem with the repair cost is that it can range from very expensive (>$100k) to relatively cheap (<$5k), but there’s great uncertainty because it’s very hard to estimate until you actually get in there and start pulling out floors and walls and roofs – which you cannot do until AFTER you purchase. So you have to negotiate the purchase price based on highly imperfect information about the extent of damage and what it might cost to repair.
But also, remember the worst case scenario is simply to demolish and rebuild the entire property. As long as zoning laws haven’t changed dramatically in a way that would cause a rebuild to be a “non-conforming” use, then your worst case cost scenario is simply the new build price per square foot.
That risk might be worth it if the initial purchase price is low enough (i.e., purchase price + new build price is less than property value in a normal sale transaction). But I’d say it’s rare for those economics to work: it’s unlikely you’ll find a property priced low enough that you can still afford to knock it down and rebuild it all over again and STILL have enough cushion leftover to earn a reasonable return on your time. Obviously it’s not worth buying a house for $50k only to have to rebuild it bottoms up for $150k and then find out similar houses only sell for $170k, or $200k, or even $220k. Just not worth the return on your time.
Also, keep in mind that banks may not even lend on a property that has major foundation, water, or termite damage. Or if they lend, they may not give you a good loan-to-value ratio. Generally I want at least 80% paid by the bank so I can earn a greater return on my equity and spread out my cash (or just keep more cash on my balance sheet). You never know when that rainy day is gonna come.
The point is, there are many considerations – repair cost, damage uncertainty, purchase price, loan availability, sale comps – that you have to be mindful/careful about when you get into a rehab. You can lose your shirt if you’re not careful, but you can also make a lot of money if you know what you’re doing.
I’ve been blabbing for long about the considerations/consequences, but when you’re actually viewing the property what exactly, specifically, should you be looking for?
The main thing you want to know is whether the foundation is solid. Solid means no material cracks, shifts, or leveling issues.
You should distinguish between material damage vs. normal settling. Every house “settles” into the dirt over a period of years after it’s built. The house’s weight contributes to this, the dirt shifts around a little bit (especially when it expands and contracts with rains), and in places like California seismic activity can also jitter things around.
So in the normal course of settling, there might be small cracks or leveling that occurs on the foundation slab. That’s normal.
But how do you tell normal vs. material? And how can you even see it in the first place, given that the property sits bolted/secured to the foundation slab and, unless there is a crawlspace or basement, it won’t be visible unless you pull out all the floors?
Well, you look for clues inside the house that help you infer the severity of any foundation imperfections.
- Open all interior doors to make sure they open and shut property. If several don’t, it may be an indication of foundation shifting/leveling that exceeds normal settling. If it’s a single door, it might just be poor framing, but if it’s more than one, especially relatively close to each other, then it might be a foundation problem.
- Bring a marble to roll on the floor to test its leveling. If there are concerning leveling issues, then rolling a marble on the floor should catch it. Walk the entire perimeter of every room in the house – from the center to the four corners. If you sense unevenness in the floor when you step around, then drop a marble on the floor to see if it rolls (a bad sign). If the house has carpet, you won’t be able to do this, but even carpeted houses usually have some hard flat flooring (e.g., kitchen, bathroom, garage, foyer, hallway) where you can roll a marble. If the house has hardwood or vinyl plank flooring, then another clue that indicates potential foundation problems is when there is visible separation at the plank seams, or any kind of bulging in the planks. If you can see planks separating or splintering or bulging, that’s a bad sign.
- Pay attention to cracks near window frames and door frames. At the corners of window frames and door frames, you’ll often see cracks. Sometimes the cracks are straight, sometimes diagonal. Sometimes they’re hairline cracks, sometimes they’re big. Almost all houses have some cracks in the corners due to normal foundation settling, so don’t worry just because they’re there. What’s concerning is if you see 45-degree diagonal cracks from the corners where the gap is large enough to stick your pinky through. If it’s just a hairline crack or a vertical crack that’s not too large, you probably don’t have anything to worry about. Keep an eye on it if you decide to buy the property (especially if the property is less than 5 years old) but in most cases you’ll be fine.
Termites are common in houses, so don’t necessarily be alarmed if disclosure reports show evidence of termites. If there is historical termite activity but preventative measures are regularly taken to kill/block them, then you’re probably OK.
Since termites may return to the property year after year, what’s important isn’t whether they’re there but rather whether there is regular (at least annual) inspections/remediation done. It’s probably not possible to keep them off the property 100% of the time, but you can clean them out annually and make it harder for them to get back in.
Usually that means injecting termite poison into the dirt surrounding the house, under the foundation, into wood beams where they’ve been observed, destroying any visible tubes on the walls, even tenting and fuming every few years (expensive).
When you are inspecting, you’ll want to look out for:
- Earth to wood contact on exterior siding because that gives termites an entry point to the wood.
- Veinous-looking dried mud tubes clinging to the walls. Termites build these tubes to ascend the walls to get to wood beams high off the ground.
- Exposed rotting/soft/chewy wood members/planks. Rotting wood is often due to water contact/damage, and they are a magnet for termites because continuous water contact isn’t able to dry and causes cellulose in the wood to break down and become soft/chewy, which termites love. This happens especially near the ground on door frames, exterior wood paneling, or anywhere wood touches each other and doesn’t have air to breathe/dry out.
- Visible condition of attic rafters and joists/beams. Since the attic is a big cavity space that probably has at least a few small openings to the open air outside (e.g., through heat vents), it’s easy for termites to get in there. Remember termites can fly. With a big open space like an attic that’s warm and insulated and has lots of exposed beams, it’s common to find termites feasting on rafters/beams there.
- Drywall holes where you see termites emerging from. This is more than nail or pin holes. I’m talking about holes you can put your finger through. They provide an access point for termites to get inside the walls to the studs. If termites find their way in there and start breeding inside the walls, it’s really bad. Because then they’re nesting right next to a food source, eating away at your studs which happen to be the structural support for your house. Even if you patch the holes, once termites are in the walls, they can build a whole colony and it could be years before you notice it; by then, extensive damage might be done.
Water is particularly important to be vigilant about.
Since water access (faucets, drains, pipes) is necessary for modern living (cooking, hygiene), you can’t simply eliminate water problems by removing water access from the house. There WILL be water inflow and outflow you have to deal with, and since water use is daily, that means more chances for water to damage the house, and there’s no way to avoid that.
What you CAN do is stay vigilant about protecting against water, and do regular (quarterly) inspections to catch problems early. Put inspection clauses in your leases and then inspect sinks, bathtubs, toilets, and kitchens at least quarterly because tenants may not timely report water related problems to you.
Like termites, water can cause problems that quietly damage your property for years before it finally caves in. It can cause mold (health hazard) and fungus growth. It can rot away plywood and beams through cellulose breakdown, which attracts termites once the wood becomes soft and chewy. That’s why it’s important to be vigilant about it from the very beginning.
There’s a ton of ways water leaks out. Leaky pipes. Leaky faucets and drains. Poorly sealed bathtub/sink caulk. Shifted toilet wax ring. Leaky roof. Leaky window seals.
For this reason, when you’re doing due diligence, look carefully around any water source. Look at every point of water entry and exit in the bathrooms, kitchen, and laundry rooms. For example:
- Open the cabinet below the sink and see if there are water stains on the cabinet bottom (evidence of leaky pipes above).
- See if the toilet wiggles when you try to move it (not a good sign) – if so, the wax ring may be loose and toilet water may be getting underneath into the subfloor. Yuck.
- For shower tubs, look around all the seams to check if they’re well-sealed or there is any evidence of water oozing into the seams/cracks and potentially damaging the wall behind. Visual evidence could be bulging/uneven tiles or blistering, damp, soft drywall.
- Use your foot to press and feel around the floors of bathrooms and kitchens (especially near water sources) to gauge whether there is any bulging or buckling in the floor (evidence of water damage underneath).
Whether it’s shower tub seams, window frame seals, or sink edges, look at all edges where water comes into contact to make sure they’re well-sealed and not cracking, peeling, or molding.
If you can access the attic, look for any sign of roof leaks (water stains that discolor wood beams, dampness).
If possible, crawl into the crawlspace to look at the water pipes underneath. You’re looking for signs of rust, dripping/leaks, and water pooling on the floor. None of these are good.
In general, just use common sense and ask yourself, “how might water in this house be effing things up?” Then go look for those things.
So…is it a deal-breaker or not?
Remember, finding evidence of foundation, termite, or water damage isn’t by itself a deal-breaker. It’s just a red flag.
As long as (1) you’re willing to do the work to remediate, and (2) the price is discounted enough to reflect the damage condition and a reasonable return on your time for fixing it, there’s no reason why even severe damage should be a deal-breaker.
Because you can turn any piece of crap property into a good house. And since you want to earn a reasonable return, the only real lever you can pull to make that happen is reducing the purchase price. If you cannot make the numbers work, i.e., if repair cost + purchase price isn’t far enough below the amount you can get from a normal sales transaction, just walk away.
(2) How to reposition to increase value
I mentioned earlier two things to look for in a property visit. Besides deal-breakers, the second thing to look for is: how you would potentially reposition the property to increase value.
For our 4-plex, K and I took off a few hours from work to attend the open house (scheduled on a weekday afternoon, oddly). We walked the building backward and forward, several times. We asked many questions to the sellers, agent, tenants.
While there were certainly minor defects and a long list of deferred maintenance problems, there were no deal-breakers apparent. Not even moderate damage. The building was solid.
And we saw a lot of potential to reposition the unit because it was being significantly undermanaged. The sellers were not operating the property like a business. As a result, rents were about half of what they should be.
For example, the units lacked some easy, fairly inexpensive, low-hanging fruit, value-add upgrades that any desirable pay-on-time tenant would expect in a modern rental: dishwashers, updated countertops, large-bowl toilets, updated or at least repainted cabinet exteriors, new carpets.
Additionally, the interiors were all painted a very drab stock landlord color that looked like dried mucus. A two-tone refresh paint job would go a long way. For finishing touches: shave off popcorn ceiling, add recessed lights, recaulk shower tubs and sinks, and the units would look a LOT more attractive/presentable to desirable tenants (especially with how good the location is).
All these upgrades were fairly inexpensive in isolation, but of course total costs do add up. Therefore, bigger ticket items like repainting the building exterior and replacing all the windows with bright new vinyl inserts would be deprioritized initially and revisited later.
The point is, from the moment you step foot into the unit on your very first visit, start formulating in your head a list of renovations and upgrades you would make as the new owner. Rank order your list based on bang for buck. The most bang for the least buck. What will most efficiently increase the desirability of tenants and rents? What would persuade YOU to want to live there if you were renting?
Generally, that ranking will be:
- Kitchen (appliances, countertops, cabinets)
- Bath (shower, toilet, sink)
If you had to prioritize one thing above all others for upgrades, I would strongly recommend making the kitchen nice and comfortable. Doesn’t have to be high end: you don’t need quartz countertops, Bosch appliances, or custom cabinets.
Instead, get stainless steel appliances from less expensive brands like Whirlpool, GE, or Samsung. Put in granite tiles for your kitchen counter in a diagonal pattern, like you sometimes see in entryway foyers of high-end homes. This will be far less expensive than custom-cut granite but will deliver most of the impact. Repaint your cabinets bright white rather than replace them.
All these will be a small fraction of the cost of doing everything custom and using high-end appliances, but will give you 80% of the same look and feel.
The point is, be thoughtful about how “efficiently” you are spending your dollars and always be able to articulate clearly why and how spending those dollars will result in higher quality tenants and higher rent.
Important property visit tip: record video
When it comes to property visits, one key tip I urge you to do whenever you visit a new property is use your phone to take LOTS of photos and video.
Ask permission to the agent/seller/tenant of course, but usually they won’t have a problem.
Say you want to record to share with your spouse who couldn’t make it or so you can revisit key details later without having to schedule a follow-on showing after all the properties you visited blur together in your head. Then record detailed video walkthroughs of every unit you’re able to access in the property.
Yes, it takes time and effort to do this, but you will be SO glad you did.
You will constantly go back to review (especially) video to refresh your memory on floorplans, building materials, lighting, dimensions, etc. Rather than have to bother the seller/agent to show the property again (probably impossible in competitive markets anyway), you’ll be able to just pull up your videos and scrub through them to refresh key details.
In fact, the more you like a property, the more you’ll rewatch the videos because more and more questions will come up that you have to refresh your memory for when you get really serious about a property. In other words, the more you like a property, the more important recording video will be.
For places we wrote offers on, I think I watched my video recordings at least 20 times on average. For the 4-plex, I must have watched it 50 times by now.
Another major benefit to recording video: if you’re remodeling, you can start getting ballpark quotes even before you close (sometimes even before you offer) by uploading your video to YouTube and then emailing requests with links to your YouTube videos to contractors. That just gives you more chances to get better information and a head start before you have to make irreversible decisions about the purchase.
I did this once I became serious and it saved a TON of time (because I can start remodeling much faster since I’ve already done pre-legwork to gather quotes and bids) and it also helped me filter out many contractors quickly and efficiently (e.g., unresponsive ones or who had poor customer service). I then brought “finalists” in for property visits/inspections to provide formal price quotes, saving everyone a lot of time.
Here’s how I recommend you record videos.
- Start from the outside of the house and record as you walk into the front door.
- Systematically go through every room and hallway. Important: self-narrate a voice-over describing in plain language exactly what you are seeing, as if you were transcribing a raw text narration for a blind person. Describe aloud lighting levels, size of key rooms (“12 paces by 10 paces”), materials used for key surfaces (“kitchen countertop is granite not quartz, appliances are Samsung stainless steel, and the floor is travertine tile”), whether you observe any defects or leaks or broken items (“looks like there’s water stains in the bathroom cabinet directly below the sink pipe, could be a leak”), what direction windows face, any floorplan/layout oddities (“ok, the master bathroom actually has an extra doorway making it accessible from the hallway”).
- Stand in the corners or doorways of rooms and do a side to side camera pan so the video can see the full footprint of the room. Arc the camera up toward the ceiling and then pan back downward in a reverse arc to get walls and floor. That way you can see both the look and feel of the room as well as the construction materials, lighting, flooring, etc.
- In bathrooms, open the shower tub door/curtain to video inside so you can gauge size, condition, and cleanliness.
- Have doors and cupboards throughout the house already pre-opened so the video can see inside without you having to constantly dip back and forth to open them. Be sure to video inside coat and linen closets to gauge their size and depth.
- Video the outside of the property by walking fully around it, including the backyard. Narrate observations about foundation/pavement cracks, any tree stumps, roots, or branches that pose risk of damage to the property, condition of the outside walls (dryrot, sun damage, peeling paint, holes?), landscaping, roof condition (“some shingle tiles are missing”), gutters (“drainspout is detached from the wall clamp”).
- Video a 360 pan of the surrounding street and houses. I like to record a 360 sweep of the immediate neighborhood at the beginning or end to better understand the property in the context of its neighbors. Narrate the look and feel (outside cleanliness, repair condition, how clean/dirty the street is, whether there’s litter on the ground) and tie it back to the impression it gives about the property itself.
Don’t forget to drive the neighborhood streets
Unless you know all the streets around the property like it’s your own backyard, I strongly recommend spending 1-2 hours just driving the neighboring streets to get a good feel for the area at different times of day.
Try parking across the street from the property (like the cops on TV who stake out a joint) to see who the neighbors are, who’s goes about the area, what it feels like to be on that street.
Drive all the parallel and perpendicular streets to get a feel for them, too. Are the streets clean? Safe? Quiet? Well-maintained? And ultimately: would YOU be willing to live there?
For the 4-plex, we drove back and forth and up and down the neighborhood, crawling every street in our car, feeling out every major street corner, asking ourselves those same questions.
We drove the area several times at different times of day. We talked to random neighbors to ask how they liked the area, their experience living there, what they would advise someone considering moving to the area. We forced ourselves, in detail, to articulate what we liked and disliked; then we prioritized the importance of each item.
This exercise helped us put our feelings about the property, the price, our envisioned renovations into fuller context. A property is tied to its neighborhood, after all, and the environment greatly impacts its value and attractiveness.
By the end, we had developed a clear opinion of the strength of the property given the neighborhood and where we thought the neighborhood was headed.
Next: The agent, offer, and negotiation strategy we used to win
In the next post, I’ll talk about the agent strategy we used to position our offer, and how we negotiated to get our offer accepted.
Discussion: What’s your process for inspecting a property? What do you look for and what have you learned the “hard way”? What are your deal-breakers? Do you record video? What are powerful ways to reposition you think can add value that others don’t understand? Share a comment below!