New real estate investors frequently neglect a critical element on their budgets. It’s the contingency expense. A contingency is the amount of money set aside for unplanned expenses. While it’s important to include a contingency in the budget before purchasing any investment property, adding a contingency expense is crucial before starting a major construction or home improvement project.
It’s risky to purchase a home as an investment without budgeting for unexpected costs. It could become necessary to find additional funding to complete its renovation. Worse, the home could fail to net a positive return on investment. Experienced real estate investors typically use a percentage of the overall rehab budget to set the amount of the contingency fund. The number they choose for the percentage depends on whether the renovation project is minor, moderate, or major.
The contingency fund can be set from 5 to 7 percent if the property only needs minor improvements. Such homes are in good condition but could benefit from cosmetic improvements. Minor repairs do not require a licensed professional or permits. Interior painting, new faucets, planting flowers, or replacing the carpet are examples of what sort of improvements most investors would consider minor. An increase in the cost of materials or a need for additional materials are frequent reasons investors need to tap their contingency during a minor renovation.
Adding 10 percent for contingency is typical for properties requiring moderate repairs. These types of repairs require permits and licensed contractors. Homes in this category need at least one substantial upgrade like a completely renovated kitchen or bathroom. Discovering an unforeseen problem when the walls open up is common with these homes.
A Major Rehab
Budgeting 15 percent for contingency is traditional when the home needs major improvements. These homes require extensive repairs such as addressing foundation problems, rewiring the house, or replacing the roof. Also, these properties are likely to have problems that were not visible before purchase.
Budgeting a contingency expense of 5 to 15 percent is prudent before buying an investment property. No matter how well an investor estimates repair costs, unexpected expenses can arise during minor, moderate, or major improvement projects.