It is true what they say: you need to spend money to make money; nowhere is that concept more apparent than the almighty real estate development cost breakdown. It is in spending money on proper construction projects, after all, that adds significant value to a subject property. What is the definition of a successful flip, after all, if not for one that you put a little bit of money into only to realize more on the backend? There’s no doubt about it; the real estate construction cost you incur in rehabbing a home is a necessary evil, but one that can really work in your favor if you mind due diligence.
However, it is worth noting that not all real estate construction costs are created equal, nor will they estimate themselves. No, as a real estate investor, it’s up to you — and you alone — to not only identify the most important construction projects for a rehab, but it’s also your responsibility to estimate how much they will cost.
If you want to learn how to estimate real estate construction costs effectively, look no further. Continue reading to find out which costs you need to pay special considerations to, and how they factor into your overall exit strategy.
No two construction jobs are created equal, but there are projects which are universal. In fact, below you will find a reliable real estate development cost breakdown:
Paint: It is almost always a good idea to paint your rehab. Be sure to add the cost of paint and labor to your estimates, as they will most likely contribute to a better product, no matter what.
Hardwood: It is quite common for real estate investors to replace floors, whether they are wood, tile or carpet. That said, there’s a good chance your rehab will benefit from new floors.
Kitchen: Includes cabinets, countertops, backsplash, plumbing, electrical, sink, garbage disposal, faucet and additional amenities.
Appliances: Includes refrigerator, range, range hood, dishwasher and microwave.
Bathroom: Include vanity, countertop, mirror, sink, faucet, tub, surround, shower, faucet kit, towel bar, fan, lighting, basic plumbing and electrical.
Framing: Includes new construction framing, framing changes, opening load bearing walls and subfloor plywood.
Insulation: A good product should be insulated, so be sure to budget for insulation in the walls and attic.
Walls: Set aside some budget to take care of any damaged walls, and even to remove unwanted popcorn ceilings.
Doors And Trim: It is almost always a good idea to replace interior doors.
Basement: Putting some money into the basement could pay huge dividends.
Foundation: Make sure the foundation is solid and void of any issues.
Roof: Will you need to replace or repair the roof?
Gutters: Will you need to install new gutters or simply clean them out.
Siding: Are you going to repair the siding or change it altogether.
Masonry: Be sure to check the mason work around the chimney or any other brick and mortar work.
Painting: I recommend painting the home no matter what; it has a way of freshening any home up.
Windows: Replace windows if need be; they will make a huge difference in the final product.
Garage: Don’t forget to account for finishing the garage and the garage door.
Landscaping: A freshly landscaped yard can work wonders for curb appeal.
Concrete And Asphalt: Makes sure cracks in the foundation aren’t serious, and proceed to fix them.
Wooden Amenities: Don’t forget to check fences, pergolas and decks for any work they may need.
Septic: Not all homes have septic systems, but make sure you account for yours if you have one.
Pool: Pools can be tricky. If you are going to keep it, make sure it is a selling point and not an eyesore. If you aren’t going to keep it, you need to account for filling it in.
HVAC Unit: Sometimes you may need to either inspect, repair, or install a heating, ventilation and air conditioner unit.
Light Fixtures: Depending on the condition of the existing light fixtures, you should probably consider installing some new ones.
Electricals: Many old houses may need a new electrical panel installed, or require you to update the electricals throughout the house, altogether.
Water Heater: Water heaters are often neglected, but deserve your attention. Don’t forget to factor in this cost if your home needs a new one.
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Construction hard costs, as their name would lead you to believe, are costs incurred from physical construction, not excluding equipment. Otherwise known as “brick-and-mortar costs,” hard construction costs are most closely associated with the building’s structure, site and landscape. Perhaps even more specifically, however, hard construction costs are typically more tangible than their “soft” counterparts, and are therefore easier to estimate. For a better idea of some of the hard construction costs you could expect to see on a job site, here are some prominent examples:
Labor required for construction
Materials required for construction
Contradictory to the previously discussed hard construction costs, their “soft” counterparts are those costs that aren’t directly correlated to construction costs. In other words, soft construction costs are costs incurred from indirectly working on a subject property. Common soft construction costs include, but are not limited to:
Architectural and engineering fees
However, it is worth noting that soft costs don’t end once a project is complete but rather extend beyond the completion of a project. Building maintenance, insurance, security, and other fees incurred after the initial project has been completed are considered soft construction costs.
Pinpointing the real estate construction cost you can expect to incur on your next project is no simple task, but it’s not impossible. Fortunately, the entire process can be broken down into five steps:
Understand Your Market: Mind due diligence and develop a better understanding of the market and the people you intend to sell the home to. That way, you will know which upgrades to include and whether they should be high end, low end, or average. Remember, you can’t possibly know how much something will cost if you don’t know the exact item you intend to upgrade with.
Walkthrough The Property: This is where you will take the time to walk through the property and inspect every square inch physically. Take note of every detail, namely, what needs to be fixed, replaced, or added.
Confirm Condition: Be sure to go through everything with a fine-toothed comb. Ensure lights work (or don’t), HVAC units do their job, and everything else is in working condition. Then, proceed to identify your end goal for each item on the list. Does it need to be upgraded, fixed, or replaced?
Determine A Price: Here’s where things get tricky. At this point, you should have a list of everything you want to do to the house. From here, it’s as simple as assigning a value to each item on your list, but I digress. That’s easier said than done. It would help if you had an idea of how nice you want each of your “fixes” to be. For instance, if you are rehabbing a home in a high-end neighborhood, you will most likely want to use high-end materials.
Account For Every Detail: Rehabbing a house is a complex process; there are a lot of moving parts. It’s entirely too easy to leave things off your to-do list, but try your best not to. That said, there are several miscellaneous real estate construction costs that need to be considered. For example, soft construction costs (like permits, taxes, and insurance) are easy to overlook.
There’s no doubt that this list simplifies the real estate development cost breakdown, but it hits on some critical points, not the least of which includes due diligence. Estimating real estate construction costs is, after all, reliant on acute attention to detail. You need to be able to envision what it is you want, see it, and execute your plan. To do so, follow the five steps outlined above.
Learning how to calculate construction costs is an acquired skill. What’s more, calculating construction costs on a new home is entirely different from rehabbing an existing home. Starting from scratch completely changes things. In addition to the usual calculations rehabbers use, those calculating new home construction costs should do the following:
Finalize Floor Plans: Building a new home allows owners to work with a blank canvas. In the beginning stages of a project, however, no floor plan is finalized. That said, to estimate construction costs on a new home, owners will need to have access to the final floor plans. There’s absolutely no way to get a real estimate of how much a project will cost unless the final floor plans are available. Investors will also want to confirm they are working with the right plans before moving onto the next step.
Identify Construction Costs Per Square Foot: The concept of identifying how much your construction costs will add up to per square foot is relatively simple. For starters, you first need to determine the total amount you anticipate spending on your rehab. Again, doing so requires acute attention to detail and a mind for due diligence — there are many costs, and you need to account for every one of them. Next, you identify the amount of usable living space the home has. When you have both numbers, divide the total cost you expect to spend on the rehab with the total number of square feet in the home; that should give you a good idea of how much the rehab will cost per square foot.
Determine The Style And Quality Of The Home’s Amenities: The style of the home and its respective neighborhood will also play a huge role in the impending construction costs. For example, homes in a luxury neighborhood will require luxury amenities; there’s really no other option. The home needs to at least compete with local comparables. Therefore, investors will want to look at what their closest comparables have to offer and match them. This will give investors a good idea of the quality of materials and amenities to include, which can greatly impact project costs.
Leave Room For The Unexpected: It’s unfortunate, but a project is rarely brought to completion without suffering any setbacks. Almost every construction problem will run into obstacles. That said, it’s important to at least expect something to go wrong. That’s not to say something will go wrong, but rather that your budget should be ok in the event something unexpected pops up. That way, you won’t be set back too far if additional costs are added to the balance sheet.
Proactively Mitigate Overspending: Investors are advised to make their homes slightly better than comparables. That said, it’s not always a good idea to include the most expensive amenities and materials. While doing so will make the home look and feel great, the return on investment isn’t necessarily there. Instead of getting the best available, include amenities that are merely a little better than the ones other houses in the neighborhood offers. That way, you’ll have more attractive profit margins and retain demand at the time of a sale.
The formula for calculating the price per square foot isn’t all that difficult. However, there are subtle nuances that need to be considered, like, for example, what areas can actually be counted towards the square feet of a home. Consequently, not all square feet can be calculated, so it’s important to know which areas a homeowner can account for. Once you know the exact square footage of a home, all you need to do is follow this equation:
Home Value / Square Feet = Price Per Square Foot
A truly great real estate development cost breakdown isn’t complete unless it accounts for common mistakes. If for nothing else, all costs are created equal, regardless of whether or not they were planed. Having said that, here’s a list of the costs real estate developers need to at least plan for, even though they hope to never see them:
Underestimating real estate redevelopment costs
Leaving out or missing individual costs entirely
Not accounting for supply chain delays and disruptions
Assuming nothing will go wrong and best case scenarios
Accounting for weather delays
Ignorance of local labor laws and customs
Improper planning and neglecting due diligence
Neglecting to account for inflation
Inaccurately calculating both supply and demand
Not leaving yourself any downtime to account for delays
Changing orders frequently or at inopportune times
Learning the ins-and-outs of the real estate development cost breakdown is an invaluable skill exhibited by today’s best investors. That said, it’s not a skill they are born with; estimating construction costs with the lowest degree of error is a skill that can be learned and honed. Those who master the real estate development cost breakdown will find themselves with a distinct advantage, one that can simultaneously mitigate risk and increase profit margins.