In probate and trust real estate sales, there is one question that almost always comes up after the decision to sell has been made; should we sell the property (or properties) in the estate/trust “as-is” or should we improve it and then sell it?
This is no doubt a very important question; and one that should not be answered before some sort of analysis takes place.
In my opinion, an analysis of whether to sell “as-is” or renovate then sell, should center around the following 5 factors: holding costs, disclosures, risks & liabilities, expected net profit, and the current state of the real estate market.
Involves determining the holding costs of the property; i.e. what does it cost the owner, per month, to own the subject property. This should be a relatively quick addition equation of the following costs: mortgage payment, property taxes, insurance premiums, utilities, HOA payments, Mello Roos, maintenance costs, and accruing penalties of delinquent balances (if any).
- Mortgage payment – $5,550
- Property taxes – $1,300
- Insurance premiums – $150
- Utilities – $250
- HOA payments – $250
- Mello Roos – $0
- Maintenance/repairs – $250
- Accruing penalties of delinquent balance – $0
An example property purchased for $1.3M could cost appx. $7,750/month in holding costs (see breakdown above). Assuming these numbers, a 3-month renovation would likely cost the owner $23,250 in holding costs to achieve a higher sales price. This figure (the cost to hold the property during the “improvement period” should always be accounted for when answering the question: “should we sell the property “as-is” or should we improve it and then sell it?”
It is important to understand the required statutory disclosures when selling real property. According to CA Civ. Code Sec. 1102.2(b), real property transfers by a fiduciary in the administration of a decedent’s estate, guardianship, conservatorship, or trust are exempt from many of the required disclosures in a standard real estate sale. Therefore, there is a big advantage in selling real property during probate and/or trust administration because many of the typical disclosures are not required and it becomes up to the seller to do their own due diligence. It should be noted though that a fiduciary must still disclose any material facts affecting value and/or the desirability of the property if the fiduciary knows about the condition. As such, performing renovations could erode this advantage if potentially negative issues are discovered during construction, which is not uncommon, especially in older homes.
Relates to the risks and liabilities that performing construction inherently involves. To start, just about any construction project contains risks such as: going over budget, encountering delays (and increasing holding costs), over-estimating the value of the improvements, designing too specifically, and/or “opening a can of worms;” i.e. where attempting to fix/improve one aspect of a problem leads to discovering one problem after another. Additionally, most homes are vacant when performing construction; and vacant homes are more susceptible vandalism, theft, and insurance lapse.
Along with understanding the risks of renovations, it is also important to understand some of the liability that can be associated with construction. For instance, if construction is being performed, it should be done by a licensed contractor as well as with permits. First off, unpermitted construction must be disclosed when selling real property; yet buyers are typically “off put” by unpermitted revocations. Furthermore, a seller can be held liable (including punitive damages) if such unpermitted work is not properly disclosed before the sale take place. Therefore, the incremental savings of not paying for permits is largely outweighed by the potential liability (if not disclosed) or the diminution in value to the property in the eyes of buyers (if disclosed).
Lastly, it’s important to note that unlicensed contractors should not be hired for jobs worth more than $500, because unlicensed contractors do not have workers’ compensation and owners will be liable if someone is injured during the construction period. The same rationale stated for unpermitted construction applies here, the costs severely outweighs the benefits (of potentially paying an unlicensed contractor less money).
Involves assessing the projected additional profit from performing the proposed renovations/repairs; because after all, the sole purpose of improve the real property is to “net” more proceeds. Once again, a simple math equation should make this a relatively straightforward analysis. The projected sales price (post-construction) – the cost of renovations – holding costs – the “as-is” value = the additional profit from construction. Below are some example scenarios using actual dollar amounts:
$1,500,000 (projected sale price, post-construction)
$100,000 (renovations costs)
$15,446 (holding costs)
$1,300,000 (“as-is” value)
$84,454 (net profit from renovating the property)
In Scenario #1, we assume a property can be sold for $1.3M in its “as-in” condition. We are also assuming that a $100,000 renovation will result in a $1.5M sales price and it will take 2 months to complete the scope of work. If we look back to factor #1 (on “holding costs”), we assumed holding costs of $7,750 per month for a $1.3M property. Therefore, in this example, we predict $15,500 in holding costs will be incurred to engage in a 2-month renovation. And if we apply these numbers to the math equation above, we would get an $84,500 profit for engaging in certain renovations prior to sale. If this scenario were true, this would be money well invested.
$1,473,000 (projected sale price, post-construction)
$110,000 (renovations costs)
$23,250 (holding costs)
$1,300,000 (“as-is” value)
$39,750 (net profit from renovating the property)
In scenario #2, we will make a few minor tweaks to the assumption and results of the construction project. First off, we will assume we over-estimated the “after-renovation value” of the property by $27k (i.e. a 1.8% mistake). Secondly, will assume the construction budget went over $10k and the construction timeline went 1 month longer than anticipated. If we factor in these 3 adjustments to our simple math equation (shown above), the bottom line “net profit from renovating the property” shrinks to $39,750. Now while appx. $39k is a lot of money, it does become more difficult to justify the risks and liabilities associated with construction for an addition $39k (even the smallest lawsuit, accident, or setback can wipe out a $39k gain).
Please also note that while I refer to this analysis as “simple math,” this is a misnomer since the assumptions behind the numbers are not simple. They require a significant amount of due diligence and experience in order to arrive at them.
Involves assessing the spread between the “as-is” value and after-renovation value (“ARV”) as well as the state of the current real estate market. Both of these observations are important because they will give the seller an idea of how much margin (upside potential in sales price) there is and which way the real estate market is trending. Regarding the latter, a bullish real estate market, where real estate values are increases steadily, lends itself to less risk in choosing to renovate a property prior to sale. Conversely, an uncertain real estate market would sway the pendulum more towards selling “as-is.”
While there are of course other factors that could play a role in the decision of whether to sell “as-is” or renovate then sell, I believe these are the core factors that should, at a minimum, be considered before acting. With that said, I did want to layout some final thoughts, this decision is never one way or the other (always), it should be a case-by-case analysis. And lastly, it is important to assemble the right team to assist in this decision making process, I recommend consulting with a real estate agent/broker to assess the “as-is” value, after-renovation value, and whether the work proposed justifies the anticipated sales price (2+ opinions are best), a CPA and attorney to get their opinion on the tax and legal effect of the proposed action, and finally an estimate and timeline for the proposed work (2+ opinions are best).
DISCLAIMER: This content is meant purely for educational purposes. It contains only general information about real estate and legal matters. It is NOT legal advice and should not be treated as such. We recommend consulting a legal or tax professional before acting on any material, opinion, or perspective described herein. ***