Renovating your investment property – or any property for that matter – is an exciting and fun experience. You’ve no doubt watched the home make-over shows and read about other peoples success stories in magazines and gotten inspired yourself. If you are considering a renovation you’ve probably started by thinking about ideas for your kitchen, bathroom, exterior, lighting, flooring etc… and looking at the products and colours you could pull together to create a more modern looking property.
This is a great start but renovating your investment property wisely is restricting and takes a lot of planning and self control. It’s not just about prettying up your property in the way that you might like it. And in fact this is exactly how you would go about over-capitalising on your renovation.
A smart property investor will make a plan right from the outset that purely focuses on how they will make a profit from their renovation.
If you think about planning your renovation enough in advance, you will even consider it before you decide on a particular property.
Renovating the right property could be the difference between making a profit and not. If you’re planning on a cosmetic renovation, then selecting a property that requires minimal ‘invisible’ work is essential. Invisible renovations include things like re-wiring a house, replacing a roof that you can’t see from the road, installing insulation or repairing general damage to the property. Cosmetic renovations that may or may not include small structural changes (for example building an interior wall to create a new room) have worked extremely well for me and the many many clients I have advised in the past. This is not the only way to renovate (you may choose to add a level or do even more structural work to your property) but it is a quick, low risk, reasonably low cost way to force value onto a property.
Choosing a property that you can perform minimal work on but that dramatically improves its appearance is of course, key. Some properties are just simply too expensive to renovate compared to the return you would earn. For the best returns on a cosmetic renovation, choose a property that is 15-35 years old and out of style/old fashioned (1970’s, 1980’s or 1990’s – and at a stretch 1960’s).
The next step is to work out the feasibility of renovating the property you’ve chosen. The best way to work out your potential profit is by asking real estate agents and scouring the internet to find out what other properties are selling for. Compare your property to others that are a similar style and size (number of bedrooms and land size) – especially those that have recently been renovated. If your property is currently worth $400,000 and other renovated properties are selling for $450,000, then you may not consider there is enough ‘fat’ in the project. However, if there are examples of properties that have sold for $480,000, you might consider this enough of a profit to pay you for your time, investment and risk.
When doing your numbers, an essential thing to know, of course, is how much your renovation is going to cost. The area the property is located in, the type of property it is and what you are planning to do with it (sell, hold short or long term, rent out etc…) will all go to deciding how much you should spend on it. When advising my clients about what exactly to do to their property to improve it most effectively, for the least cost, I typically work to a budget of 5-7% (of the property’s pre-renovation value). Using this strategy, on a property currently worth $400,000 the specifications I give them would be based on spending around $20,000 on the renovation. It’s very easy to spend over this amount, but believe me it is completely possible to stay within your prescribed budget – and avoid over-capitalising – when you have the right plan in place.
Once you know the cost of the property, the cost of the renovation and the probable end value of the property (re-valuation or sale price) then you should be able to make an accurate assessment about whether to go ahead with the deal or not.
I don’t believe that it is vital to know exactly what you are going to do to a property to know what it is going to cost to renovate. In fact, I tend to work in reverse as long as the property has good bones. I usually work out the renovation budget depending on location, property type and size etc… and then allocate my budget from there. Distribute your money around the whole property so that overall it is improved. It’s great to renovate the kitchen and bathroom but if you do nothing to the rest of the house (especially the exterior) then it could be money wasted.
Identify the worst parts of the property (not the areas, but the actual components within each area – such as kitchen bench-top and/or handles and/or splash-back and/or floors etc…). Then renovate just the components that need it. You do not need to use the ‘gut and replace’ method of renovating. You can select just a few key components to change – and done in the right way this will dramatically improve your property for minimal cost.
From the outset, keep a tight record of what you are going to do to the property. Your intention of course will be to stay within a particular cost parameter. However it can get tricky to stay on track once the day-to-day reality of the renovation kicks in. ‘Just’ $50 here and $20 there and another $60 here adds up before you know it. If you do not keep tabs on the variations that will inevitably occur you are likely to run over budget and risk over-capitalising. For this reason record keeping is vital. A simple spreadsheet will suffice – preferably on your computer so you can update it as necessary. Record on it what you are going to do (the exact specifications – product, colour, style name, dimensions etc…), who is going to do it and how much it is going to cost you. You should also keep tabs on when you expect things to be done since time over-runs equal cost over-runs usually. For example if your renovation takes two weeks longer than expected, then you’ll have two weeks of mortgage repayments you hadn’t budgeted on and that could be another $1,000 or more out of your profit.
Most of all, remember that as an investor, your renovation is a numbers game – and if the numbers don’t stack up then put your feet up and save yourself the hassle.