Could adding an extra bedroom boost your rental unit’s value and cash flow?
When Juan Huizar was still in college, he bought his first condo: a two-bedroom, two-bathroom unit with a formal dining room.
“No one pays extra for a formal dining room,” says Huizar, president of Sage Real Estate Group, a multifamily and commercial real estate brokerage in Long Beach, California. “But people do pay extra for bedrooms.”
Increasing the number of bedrooms in a rental unit is a creative way property owners can generate more income and add value to their portfolios.
If you’re thinking about turning extra space in any of your units into an additional bedroom, here are four points to consider.
1. Evaluate your space and make sure it’s compliant
Property owners need to give the market what it wants, Huizar says, and additional bedrooms are in high demand. He has turned extra space into additional bedrooms about “a dozen times.”
That said, the strategy may not work in every unit. Investors should study local laws and regulations governing bedrooms to ensure their space will comply. In California, for example, bedrooms must measure at least 80 square feet and have at least one door, window, electrical outlet and closet, according to Huizar.
“Most formal dining rooms already meet these requirements,” he says, adding that property owners can easily install a pre-built closet to check off that box.
The strategy of converting dining rooms into bedrooms has been very successful for Huizar. Today, whenever one of his clients buys an apartment building, he advises them to add bedrooms where they can.
“The landlord wins because they can charge more, and the tenant wins because there are more bedrooms for family or roommates,” Huizar says.
2. Weigh costs against potential ROI
When investors buy multifamily properties, they’re usually not making money on the first day, Huizar says. Instead, they’re focused on the next 30 years and what they can do to generate more revenue.
Converting extra space into a bedroom is the easiest and fastest way to do that, he says.
“When you’re buying a building, you’re buying an income stream,” Huizar says. “If we’re smart managers of that asset, we can increase that income stream, which increases the value of the property.”
Domenick Ferrera, executive director of Commercial Real Estate Digital at JPMorgan Chase, recently converted a two-bedroom unit in Westchester County, New York, into a four-bedroom unit. When he bought the duplex, the second floor covered only a portion of the first floor. Seeing an opportunity, Ferrera added 500 square feet to the second floor, which he made into two bedrooms.
Ferrera was then able to more than double his rent from $2,000 to $4,200 per month. Plus, adding 500 square feet to his unit — in an area where space costs roughly $300 per square foot — quickly increased the value of his property, which also increased its refinance value.
“I was able to take out the money I put in to pay for the addition and use it to repay all of the credit card loans I took out as well as repay myself,” Ferrera says.
To calculate the return on investment for your property, Ferrera suggests looking at comparable properties on the market and determining how much extra rent you could charge due to the upgrade, as well as how much your property value might increase.
“I’m generating an additional $25,000 each year, and the project cost me $100,000 all-in,” Ferrera says. “After five years, I’ll have a 25% return on investment.”
3. Work with professionals
Turning extra space into an additional bedroom is not a project most property owners should tackle on their own.
Both Huizar and Ferrera recommend talking to architects and hiring professional contractors to make sure the job is done right. To reach the most cost-effective solution, do some research and get quotes from multiple companies.
“I read a couple of basic books and watched YouTube videos to get a high-level estimate of how much this would cost,” Ferrera says. “Then I asked three contractors to give me quotes to make sure I was getting a good price.”
4. Understand tax and legal considerations
Property owners should prepare for higher property taxes when they add a bedroom to their properties, since such taxes are based on the property’s value, says Patrick O’Sullivan, owner of getMULTIfamily, a multifamily real estate brokerage in Gilbert, Arizona.
Generally speaking, if a tax assessor sees a building permit was issued to expand a property or add a bedroom, they may want to visit your property after the project’s completion and potentially reassess its value. While some property owners may be tempted to install a new bedroom without going through the legal process and securing permits from their municipality, that’s not the smartest approach.
“Most towns have a village or county code. Read through that code, reach out to the building inspector directly and speak to an architect,” Ferrera says. “I had to take out a permit for my project, but the building inspector was very helpful.”
If you don’t secure a permit and follow the proper procedures, you might run into issues later when you try to sell your property. You might also be on the hook for fines and other penalties.
In addition to paying more in property taxes, your income tax bill might increase, too, when you add a new bedroom, assuming you’re generating more revenue.
Since taxes vary by municipality, it’s important to talk to your local tax assessor to understand potential tax implications and ensure that your investment in a new bedroom pays off.
So, should you convert your extra space into an additional bedroom?
According to Isaiah Henry, CEO of Seabreeze, a property management company that manages more than 100,000 properties on the West Coast, including multifamily units, it’s an easy choice.
“If your local laws permit an additional room in your unit and you believe you’ll be able to make back your investment and then some, then it’s a wise decision,” Henry says.
By the editorial team at Story by J.P. Morgan