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Renovating apartment buildings can be costly, but with market knowledge and cost benefit analysis, it can produce results

By Derek Lobo

You just added an older rental apartment building to your portfolio. You are buying it based on cash flow, but now that you look closer you realize it looks tired and worn out. Can the building be fixed up? Can you get higher rents? What work should be done and what’s the return?

Renovating rental apartment buildings can be a costly process, but if approached carefully, with the market in mind can produce worthwhile returns in the form of higher rents and lease renewals. The challenge for building owners is to decide what renovations are worth doing and what renovations are best ignored. It’s not an easy decision to make. It takes detailed market knowledge and a focus on cost versus benefit tradeoffs.
It also requires knowledge of construction pricing and the ability to see a building as more than an Excel spreadsheet. And it takes courage.

This article offers general guidelines for renovating rental apartment buildings. Keep in mind that each building is different and must be looked at as a standalone challenge. Blanket solutions or ‘silver-bullet’ fixes simply don’t work. The only way to make informed and smart decisions about renovations is to gather detailed market knowledge. Conduct a market survey to compare your building to competitors in the local market. Once your survey is done you should be able to find answers to the following questions.

How does my building compare to its competitors?
Compare your building to its competitors in the local market looking at factors such as curb appeal, amenities, unit sizes, and rents. Does your building offer more amenities than competitors? Does your building offer larger units for lower rents? Is your building the most appealing building to renters in the local market? Or is your building the least appealing to renters than its competitors?

Can higher rents be achieved?
Rents can more easily be increased on turnover, and in most cases renovations will justify increased rents. Review the demographic profile of your tenants and the local market. Are household incomes high? Can households afford higher rents (on average) than you are charging? What is the gap between incomes and actual rents? Is the ratio of apartments to population low (i.e. supply is low, demand high)? If you raise rents and some of your current tenants leave, is demand in the local market sufficient to replace them at the higher rents?

Which renovations would make my building better than its competitors?
Assuming renovations would make your building more desirable to renters than its competitors, which renovations should be done? Compare your features and benefits to competitors. Does your building offer more or less? Which renovations would put your building ahead of the competition? Or if you can’t compete directly with competitors, which renovations would make your building unique and attract renters wanting something different?

Return on Investment
You should not choose renovations based on what you want or what your tenants want, but instead on what gives the best rate of return for your investment. How can you determine the best rate of return? The following chart shows the “acceptable rate of return” reported by landlords in the United States—with minor variations, these findings are valid for Canada as well.

What does this chart tell us? Landlords found that unit amenities such as ceiling fans, carpet upgrades, tile backsplashes, cabinet upgrades, built-in computer desks, and internet access provided a good rate of return. In other words, landlords found that including these unit amenities paid off by making their units more attractive to renters who were willing to pay more to get them.

Your building probably doesn’t include these amenities. Now ask yourself, could you include these features in your building, if renovated? How much would they actually cost? Would renovation costs be offset by increased long-term demand for your units and lower turnover?

Rate of Return on Investment (Unit Amenities)

How much should you spend on renovations?
The amount of money committed to renovations depends on the income of tenants. Why? Because you will be passing the costs on to tenants in the form of increased rents. If you do renovations but local demographics don’t support increased rents then you will have wasted your time and money on a project that won’t pay off.

How should renovations be staged?
Renovations should always be staged from “street to suite”. The first thing renters see is the outside of your building, so start outside and move inside gradually. Leave unit renovations for last. Tenants may want to live in a renovated unit, but they don’t want to walk through dark smelly corridors and across dilapidated lobbies and grounds. Once they see renovations under way, tenants who were thinking of leaving might decide to stay, while prospects will see and appreciate that the building owners care about their building. Don’t underestimate the appeal of seeing improvements underway—renters like to know and see that things are getting better.

Derek Lobo is the President of the DALA Group of Companies and ROCK Apartment Advisors. DALA has made a successful business advising building owners and property managers how and why to renovate rental apartment buildings. For more information contact Derek at dlobo@ rockaptadvisors.ca or 1-800-898-0347.