Do you have an unhealthy relationship with renovations?

With a myriad of renovating shows now appearing on television and the mixed results that some of these projects have achieved as they’ve fallen under the hammer, I thought it best to focus on the most effective renovation strategy I have undertaken, and it’s not about making profit.

With Australians having one of the highest levels of property investment per capita in the world, our love affair with property is no secret. But is a renovation all it’s cracked up to be? Will a renovation bring you that pot of gold you’ve been chasing? Could your dreams of becoming a full-time renovator and leaving the boss behind finally be realized?

Well sadly, no. Like any activity that develops over time, generating quick profits through renovating has become more difficult as property investors have become more sophisticated. It used to be fine for your Dad to buy a house, throw on a lick of paint and sell it on for a handsome profit, but not in today’s world. These days buyers know the intimate details of how much a kitchen is worth, where to get the best bathroom tiles and which paint palette is best for an investment right down to the colour selection of CaesarStone.

So let’s look at the reality of buying to renovate and make a profit.

As a useful pricing guide for unrenovated properties, I’ve found the following method quite accurate – calculate the price of the property in its fully renovated condition comparative to other sales in the area, then deduct the price of the renovation itself and what you’re left with is usually very close to what the property ends up selling for.

This may appear to be quite obvious at first, but those who have tried to profit from renovations will quickly realize the problem here.

Firstly, if you intend to sell for a profit then you also have to take into account a number of other costs before a profit is even considered.

Purchase Price $600,000
Stamp Duty & Legals $30,000
Renovation $60,000
Holding Costs – 4 mths $25,000
Selling Costs $20,000
Total Cost before Profits $735,000

In this typical example the renovator would need to increase the value of the property by over 20% just to break even! Keep in mind that if you were to sell within a 12-month period you would lose half of any profit you did make due to Capital Gains Tax

Unfortunately we’ve been so conditioned to think that carrying out a renovation will bring great profits, we now often pay a premium for unrenovated properties – meaning the price we pay for the property unrenovated, plus the added building works will often be more than if you were to buy the property new.

The main financial problem here is the 4 months holding costs and the selling costs, let alone the capital gains tax if you do make a profit.

There are people out there making good money doing renovations however. But make no mistake, these people are professionals. They study the market and they know their area and their preferred building types intimately. They know council regulations inside out. They know what works should be carried out and which ones are a waste of time. They know their build costs and most importantly, they know the price they will sell the property for before they even start.

So if this is the case then why would we renovate at all? Is it possible to add real value or are our heart strings being pulled into an unhealthy love affair with dreams of property riches.

The good news is that it is possible to add value in a renovation and it can be very worthwhile undertaking – the bad news is that it won’t be as easy or as straightforward as you think. The key word here is value - you need to be thinking long-term, adding value, rather than short-term, generating profits.

For example, we all know the importance of leverage and the compounding effects that growth can have on our property investment over time, but did you know that you can also borrow to renovate? These small loans are easy to access provided you supply the lender with a formal building quote for the work. Once that work has been completed you have, in essence, added further value to your property through the same means of leverage with which you purchased the original property. You can then wait for the compound growth to work its magic on both the value of the property and the value of the renovation over time.

Most people will also realize that a renovated property simply provides a better place to live. This in turn generates a higher level of rent that can help to pay your mortgage. (As a side note for investors looking to rent out their property, we usually equate every $10K spent renovating equates to an additional $10 a week in rent). What you may not realize straight away though is that a renovated property will also attract a better quality tenant – one who appreciates a great environment will take care of your asset responsibly and will often stay much longer than one who doesn’t.

It’s advantages such as these that we aim to provide for our clients. Having recently purchased a property for $610K, we carried out $60K in renovations, adding a further $80K to the original purchase price. This is a profit that could be realized if you refinance and it does pave the way for future compound growth at the new value of $690K. The client also received an additional $60 a week in rent.

As the client is holding the property rather than selling the finances change

Purchase Price $600,000
Stamp Duty & Legals $30,000
Renovation $60,000
Holding Costs – 6 weeks $6,000
Selling Costs $0
Total Cost $696,000 (as opposed to $735,000)

 

Cashflow on renovation
$60,000 x 7% $4,200/yr
Extra rent $60 x 52 weeks $3,120/yr
Cashflow cost $1,080/yr
Depreciation in first year est. $3,000
Capital profit $20,000

So next time you’re dreaming of a path to renovation riches, make sure you’ve considered all the costs and understand the market you’re up against. Alternatively, look to add real value through your renovation in the long-term by using the power of leverage and additional cash flow to your advantage.

 

If you would like to know more about this topic or others that interest you please feel free to add your comments or questions at the end of this section.

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