Parts is Parts

Sometimes the upgrades on a house make it worthwhile. This is especially true when the housing market is down.
When the price per square foot is down, you're going to get more bang for your buck on a repo. I just saw a house with a $60K upgraded kitchen and a $5K in flooring, and another couple thousand in crown molding, sell for $50K more than a similar house down the street that had been a rental. I'm a handy guy, but kitchen remodels are notoriously laborious. They take a lot of time and usually a lot of money.  The house was basically on sale with a $17,000 discount. The other house also had rental grade lighting and bathroom fixtures. The difference in the houses had everything to do with how much the house was cared for and loved by the owners.
The difference in price, works out to about $300/month with today's interest rates. Sure, not everyone can afford the difference, and some people don't want the extra debt. When the market recovers, the house will be worth that much more, and be that much more attractive to a buyer.
There is money to be made when the parts are worth more than the whole. This is similar in concept to the corporate pirates of the 1980's did, and what salvage yards do on a regular basis. Find something where the pieces are worth more than the whole. Obviously, you're not going to split up the house. But, if you have similar house, with dissimilar prices, it might be worthwhile to estimate how much the upgrades would cost if you plan to make them in the future.

Subsidized housing.

Over the last week, the subject of where prices for housing is going came up a lot. It was coupled with the increase in vacancies that I've seen in the rental market, both residential, and commercial.
Along with the conversations, I mentioned that the rental market is really competitive at the moment, and someone asked if I ever looked into subsidized housing, sometimes known as Section 8. I have looked into it, and decided not to get involved for several reasons. I'm going to tell you why.
Over the years, I had an opportunity to pick up some older duplexes in a low-income neighborhood. The units had few tenants, and some of the vacant units were emptied of the easily removable contents--doors, toilets, cabinet knobs, faucets, and compression plumbing under the sinks.
I started by renovating and renting the empty units. During this time, money was short, and I was working part-time and temp jobs during the day, and the units at night, and doing a variety of paperwork early in the morning. It wasn't unusual for me to be up at 5am and not in bed until somewhere between midnight and 2am. I would often get a nap at lunchtime, but I was doing a lot of 16 hour work days, 6 days a week, with a 'short' 8 to 12 hours on Sunday.
During this time I got a lot of people wandering by to ask when the unit would be ready. I had several ask me if I took Section 8. I was fairly new to the business, and told them I hadn't looked into it. When asked, I told them the rents were about $650 and nearly all of them told me that Section 8 would pay me $850 and that we could "split the difference" or something to that effect. That sort of dishonesty helped put me off. Well, I guess they were honest with me, but not with Section 8. I have an abiding antipathy to liars. However, I would give them an application if they wanted.
I  also was questioned as to why I was making the places 'so nice' by applicants. I replied, "If it looks like a sty, only pigs will want to live here." Those people never brought back the application I gave them. In the words of Dave Ramsey, broke is a condition, poor is an attitude.
Emotionally (I know I shouldn't get emotional about property--that's fodder for another article) I am a bit attached to these properties that I've spent so much time renovating. I've spent a lot of time and money, and literally blood, sweat and tears on these units. All of the landlords who do their own work that I've talked to, feel pretty much the same. All of them that have had Section 8 renters have had problems with damage to the units. The overall conclusion is that the extra money is eaten up in the repairs.
As it happens, the local paper had a trio of staff writers cover the subject. In my opinion, the comments section will give you better insight than the article itself.
Though Section 8 pays higher than average rates, there is a flipside with subsidized housing (brought up by one of the above commentators) in that it devalues real estate in the area. The people building subsidized housing  are able to charge rents that are lower than market rates (affordable). This brings down the rents of neighboring units, especially, or maybe because of, the added units cause a surplus of housing. This drives the rental housing prices down. So the government causes taxpayers to  subsidize a few large construction companies that are in competition with them.
The purpose of the subsidized low-income housing is to deflate housing prices. This unfortunately for investors, also deflates the value of their property. So it's likely, that in the near future, as bailout money gets used for subsidized housing, it will accelerate the decrease in your investment's value. Your property will become worth less faster. This is going to be especially true in larger cities.
If you drive around neighborhoods or down the freeway, you're likely to see a lot of commercial property vacancies. There are more coming. As rents go down, commercial properties are worth less. Unfortunately for small business owners, there is a lot of uncertainty as to what new taxes are in store for them and what existing taxes are going to be raised. That economic uncertainty is going to contribute to unemployment. So there are going to be less Americans compteting for housing in California.
All this makes me think housing hasn't bottomed out yet. This is especially true in outlying areas and suburbs. Though, prices are still at lows that I haven't seen since the 90's, and you can pick up housing for less than it costs to build, and less than it would cost to rent. It still might be good to buy, knowing that your purchase will lose value over the next few years, then increase after positive changes in the economy.

Size Matters

Now that I've got your attention, I refer you to the following link, which came out today (Aug. 27, 08):
http://www.realtor.org/rmonews_and_commentary/opinion/0809commentarysquarefootage
This article was extremely well timed for me as I just put an offer in for a client on a home which originally was built with 1705 sq. ft. While looking at the property in the MLS (Multiple Listing Service) I noticed that the property's listed square footage had increased 330 sq. ft. in 2005, which comported to an addition off the garage to the rear of the property. The initial issue I had with the "room addition" was that it didn't have any heating or air conditioning, so I decided to investigate the matter further (something called "due diligence" in investor's jargon). Please keep in mind, this property is an REO, and the bank is selling it AS-IS, so my client is "stuck" with what he buys, but might be able to sue me, my broker, the listing agent and his broker, or a property inspector in the future, if we miss these things.

I went to the local building and safety office and was not able to find ANY information on the property in question (PIQ), and then called the local assessor's office. I was helped by a very informative clerk, who let me know that permits had been pulled for the rear patio, the additional single car garage, a pole barn (since recycled by local bandits for the sheet metal), and a 330 sq. ft patio enclosure.

Aha! Now I had found the square footage. Unfortunately for the seller, and fortunately for my client there quite a difference between a "room addition" and a "patio enclosure." As a former building inspector and son of a general contractor working on my on GC license, I know the difference. A room addition is considered "livable space" due to the nature of it's construction, a patio enclosure is not, and is roughly worth half of what a room addition is worth on a per square foot basis for a number of reasons.

Starting from the ground up, here are the differences between the two, and hence the reason a room addition is more valuable then a patio enclosure.
1. A room addition is required to be structurally tied into the footings of the building and a patio enclosure only requires footings under the patio posts. Generally, a footing is a trench 12" deep by 12" wide with two 1/2" pieces of rebar placed near the center of the trench--1 about 3" from the bottom and 1 about 3" from the top. The rebar is generally dowelled into the existing footing of the house and this gives a continuous base to the house. In many areas a footing of this size will allow for a 2nd story, whereas a pad footing under a patio post would not.
2. Within the framing of a patio enclosure, there is no requirement for insulation in the walls or the ceiling. A room addition must comply with the standards for the house, and in the state of California, for additions larger than 100 sq. ft. must have a Title 24 document submitted with the plans for the addition for energy efficiency requirements. The PIQ is in climate zone 14, in the high desert, which is one of the harshest zones in the state, because the temperature range is over 100 degrees fahrenheit (8 in winter to nearly 120 in summer). As this was done as a patio enclosure, my client and I can't know what the R-value of the insulation is, if any, without opening the walls, and if I my client wants to upgrade to a room addition, he will have to open the walls, and probably upgrade any insulation that was originally installed in 1991 (probably R-7 or R-11) with whatever is required by his new Title 24 document (R-13 minimum possibly R-15), and then, of course, replace the drywall, re-texture, and repaint.
3. Speaking of drywall, most jurisdictions in California require 5/8" fiberglass reinforced drywall (type x) between the garage and "living spaces". As this was originally built as a patio, that was probably not done, and the insulation is not likely installed between the garage and the patio enclosure as it would not be required, like it would have been for a room addition.
4. Electrical is not required on a patio enclosure. The National Electrical Code requirement for livable spaces is "no place on a wall that is further than 6' from an outlet...excepting closet interiors" (so basically a receptacle every 12' along the walls) and a requirement for a light or a switched receptacle, that a light can then be plugged into. This patio had the light, but I don't believe it met the receptacle spacing requirements, though, to be honest, I didn't measure them, I was just "eyeballing" it.
5. Livable space must have thermostatically controlled heating, whereas, a patio has no such requirement. Strangely, as of this writing, there is no requirement for air conditioning in the desert. However, if my client tied into the existing central air, that would need to be addressed in the Title 24 of his plans or he could add a heater to the room, but that would leave him without air conditioning. The size of the room might require a larger hvac system as the old system may not be able to handle the extra volume (330 sq. ft with 8' ceilings is 2640 cubic ft.--roughly 20% additional load). California has additional requirements for heating and air systems (including duct leakage testing) that I won't go into here, but add to the cost of installing them.
6. Depending on the jurisdiction, some of the above requirements might be waived, but with the current slowdown in new home building, the building inspectors have more time to catch the defects, and my client would still need to pay to have plans drawn, submit the plans and energy compliance documents (Title 24), install the footing, add any necessary electrical and hvac, and ensure proper insulation and drywall installation, then texture and paint, and finally add flooring, if he wants to be able to legitimately claim the additional 330 sq. ft. when he goes to resell the home.

It could run from $6000 (if my client is willing and can do the repairs and doesn't extend the central heating/air--which would be silly in the desert) to $24000 if he has to hire a contractor to complete the work. I feel $15000 is a reasonable figure and reduced the offer on the listing sales price by a little more than that for a couple of other deficiencies in the property--like exterior paint, dilapidated fence, missing gate, and broken tiles in the kitchen and hallway.

So, if you're buying an REO or any other property AS-IS, size matters, especially as it helps determine price per sq. ft. (ppsf in future posts), but you need to know if the square footage indicated is truly livable space, or you could be paying more for a property than you should.

If you are in need of a house, for yourself or as an investment, please email me. I have over 11 years of real estate investing experience (mostly rehabs) and up to date experience with California energy requirements, as I was a city building inspector from 2006-2008. I would be happy to assist you in buying or selling your home. If you have questions on how to upgrade your home for the best return on your investment, I can help with that too.