Over improvement is a mistake that I believe everyone makes at least once — and usually more than once before they learn better. I have made this mistake myself and learned from it. And I’ve also been fortunate to learn from friends and mentors and the mistakes they have made. Having both the knowledge of other people’s lessons and the wisdom from having to learn this lesson myself, I am encouraged to pass both on to new investors so they can utilize them as well.
Let’s start with why over improving a property is less than ideal. It should be obvious, right? As we sink money into capital upgrades, there is a rate of diminishing returns.
Let’s look to the extremes for clarification. You don’t build a $10,000 gold-and-marble bathroom in a $10,000 single-wide trailer home. This is obvious, I hope. But it’s also extreme. What matters most is where we over improve at the margin. Meaning, should you put Formica or granite countertops in your unit? Should you put in fancy appliances or leave them white or black? Should you paint the exterior? Maybe you’ve thought about installing solar panels on the roof?
It’s hard to calculate how to maximize a return for each individual upgrade, and to sort it all out would be more work than it’s worth and ultimately not that useful. What’s most important is realizing that for a rental — different from a flip — is that you don’t need or want it to be the nicest house on the street. What we really want is to just be slightly above market-average quality, bring in top-of-market rent, and to last for the (very) long haul. Uninspiring, I know. But this is about making money, not getting on HGTV.
Rentals are not about creating emotional demand to drive sales. They are about creating a long-term viable living situation for multiple people over a very long period of time. This means passing on most fancy fixtures or complicated appliances in exchange for simple but functional fixtures and appliances. For instance, I recommend installing chandelier lights only and skipping on fans for all but the nicest of rentals. You’d be amazed how fan blades break. Water dispensers in fridges is another common skip for my units. Is it nice to have? Sort of. But it adds plumbing, extra complexity, and something that often breaks but will never create an increased return on investment. Same goes for under-sink garbage disposals. No one will pay more for this stuff, but it will for sure cost you more. So skip it!
Over-improving is probably most common in new investors. It’s just easy to get excited! It’s the first one. We want to be super proud of it, and we really want the new tenants to like it. I’m not suggesting or advocating not to care about your rentals or demand they are nice facilities. There is a space where you can make a rental look nice and have it be a great place to live without spending more than you have to. And it can be made fairly “tenant-proof” without having to make large sacrifices in quality.
Risks in Over Improvement — What’s the Big Deal?
Return on Investment is Lower
I would be inclined to think this is obvious, but perhaps not. If you over improve your property, the payback period is longer, and your return on investment in the short term is lower. This means it takes longer to get your money back, and the improvements are less efficient. Unless you intend to live forever, maximizing your time efficiency is critical.
Can’t Refi Out Your Investment
Let’s say you intended to buy a $50,000 home and put $35,000 in rehab into it. and after that cost the house is super nice. Nicest house on the block. The place looks fantastic. You find a tenant at $50 a month above market rate, almost instantly. Life is easy, right? Then the appraisal comes back and the house is worth $90,000. You’ve still created equity, but if Fannie Mae says you can borrow only 75 percent of that $90,000, you’re left with a loan of $67,000. You left $17,500 in that deal that you can’t extract, and you only earned an extra $50 per month for all the improvements. The rental next door to yours has only $65,000 in a similar house and rents for $50 less per month. You may own the superior home, but they own the superior asset. Remember, buy houses, never homes.
Higher Cost to Maintain Improvements
You went all out, you built the nicest rental. And man, the tenants love it. Who do you think is responsible for the $2,500 refrigerator you provided though? If your rental warrants buying a $2,500 fridge, then you have to. But if you buy a fridge far nicer than the next door neighbors, you may kick yourself later. The nicer a house is, the more your tenants will enjoy it. And the nicer they will expect it to stay. Again, it’s important to have a well-maintained and respectable rental, but know the overhead you sign yourself up for, especially for above market-average improvements. Putting frameless glass showers in a house that doesn’t need it is asking for trouble. If you have installed a garbage disposal, you will get calls when it clogs or breaks. And if you put expensive ceiling fans in kids rooms, you may have broken blades.
Here might be a better example: Imagine picking up a 10-year-old BMW 740i — BMW’s flagship sedan. The $140,000 car was fully loaded when new. Now it’s got 120,000 miles on it, and you can get it for a few grand, so you think it’s a deal and buy it. When the maintenance comes, you get a little dose of reality. Your $10,000 car needs $6,000 in routine maintenance — ouch! You think, how could this be? The car was only $10,000!? That’s because the maintenance requirements and costs of the car stay mostly static (or increase) while the value of the car depreciates. If you put a high-end stove in a cheap rental (or any large margin between the cost of repair and repair warranted), your long-term overhead will suffer more than the upfront cost.
So we know why we shouldn’t over improve, but how can people avoid this trap?
Stop Creating Things YOU Like
It’s certainly a common in practice, and some people even proclaim this proudly as they describe their buying style: “I would never buy a house that I wouldn’t personally live in.” That statement makes my blood boil. So let’s really unpack how short-sighted it really is. We are investors, not renters. Immediately, entering this scenario we have a different mindset, motive, and strategy than a tenant would. Why would we handicap a tenant base to requirements that are designed for an investor? What we like, or would live in, is irrelevant.