PORTFOLIO POINT: Property owners who plan to renovate with a view to securing capital growth should make sure they do a thorough feasibility study first. Value adding isn’t always the best approach, and much depends on your budget.
In the eternal search for strong capital growth, a steady but unspectacular property market – like the one we are currently experiencing in most capital cities – will set few investors’ hearts racing. In the absence of significantly rising land values, those hungry for capital growth may turn to renovating instead to keep values kicking upwards.
Renovating for capital gains is, at its essence, a simple arithmetic process. The cost of renovations should be less than the subsequent value added. Mistakenly, many people assume the value-add will always be greater than the cost. In fact, many so-called value-adding projects cost more in time and money than the market is willing to give you credit for. This is known as over-capitalising.
A good example of this is stabilising the structure of an old house where some of the stumps have rotted through, or re-wiring to modern standards. Unfortunately, the results are largely hidden from view, and the owner will not see any of their expenditure back when they come to sell or revalue the property.
So before you dive into the process of working out how much varying types of renovations will cost, you need to get a handle on how much they will deliver. This can be done in two ways. You can do thorough research over several months on the value of properties that have recently sold and that are in a comparable state to the target improved state of your property. Alternatively, you can seek professional help from an independent property adviser or valuer familiar with your location. They can give a guide as to what sort of uplift you can expect from your planned improvements.
You can then go about ascertaining the costs associated with the different levels of improvement. Always obtain a building inspection on a property you are thinking of buying to renovate, so you really know what state the property is in at the point of purchase. Then, to obtain a good ballpark figure of what different sorts of renovations cost, a great place to start is the Archicentre cost guide. It shows that costs can range from a few thousand dollars for repainting the interior walls of a house to hundreds of thousands for adding a new storey.
Of course, costs can vary markedly from this guide, depending on the circumstances of the property. In particular, where the work is more extensive and involves multiple tradespeople, it is more difficult to budget accurately.
According to Peter Alexander, owner of SafeHome Building Inspections, taking a few initial steps can help manage costs for the more extensive jobs. “Be clear about the scope of work. For smaller jobs, you can engage a draftsperson to draw up plans, and they are relatively inexpensive. You only need to consider an architect for the more complex projects.”
Once you have clear plans, it becomes much easier to brief tradespeople. In fact, many tradespeople will only quote on the basis of a proper plan. You also need to do your homework with selecting tradespeople, according to Alexander. “Always get two to three quotes but don’t go with the cheapest, and obtain and check references. Further, they should all be pretty close on the mark when quoting materials – if there are large differences in material price, one may be using substandard or non-compliant materials and should be avoided.”
In fact, for the most ambitious jobs, such as a complete redevelopment of a site, owners should recognise they need the expertise of other professionals, such as lawyers and accountants, to ensure the related raft of legal and tax issues are properly managed.
So what sorts of renovations deliver the best bang for the buck? Inexpensive superficial or cosmetic improvements – such as repainting, recarpeting, taking up carpets to expose and polish floorboards or retiling – can lift a property’s value from several to tens of thousands of dollars above the relatively modest cost.
Focusing on upgrading the wet areas in the property – kitchen, bathrooms and laundry – is also valued by buyers. The work can be relatively modest, such as replacing doors and handles on existing work benches and storage spaces, through to engaging a cabinet maker to replace them all.
Increasingly, people are looking for easy to maintain properties, so it can be fruitful to focus on making a property just that – for example, creating a low-maintenance but attractive outdoor barbeque area.
Projects that deliver more accommodation or significantly enhance lifestyle are often successful.
If an investor is of the mindset to buy, renovate and hold for the long term, this can make some more costly structural renovations financially viable, as the benefits will flow through to the renovator and the costs can be depreciated over several years.
For bigger jobs, there is often a cheaper (but still good quality) approach. For example, a roof restoration, rather than replacement, can be very effective. Alexander advises that repairs, repoints and seals can cost between $2500 and $3000. “It comes with a 25-year guarantee and looks like a new roof without the $25,000 price tag.”
Ultimately, investors have to decide whether adding value is the right approach. The old adage of 'buy the worst house on the best street’ and do it up can be a bit of a blind alley, or even a myth. You may well be better off spending more on a property that is structurally sound, rather than stabilising a building or reinstating its original features.
If you want to add value, start with the basics in place. Ensure the existing structure is sound, the location is appropriate, and the floor plan logical and conventional. Then look at your budget and decide to what extent it allows you to add value. A modest budget means cosmetic improvements. Deeper pockets will allow you to weigh up the merits of adding lifestyle-enhancing features or more accommodation. Whichever way you jump, be very certain to do a full feasibility study and gather a team of independent advisers together to guide you through the process.
- Negative gearing.
- Is RP Data's house price index useful for timing the market?
- When to sell a property that isn't performing...
- And the best times to sell generally.
I am a high income earner looking to negatively gear an investment property for up to $1 million, but am unsure about which location and type of property will produce the best capital gain in the long term. I live in Melbourne and this is where I am interested in investing.
At $1 million, the Melbourne marketplace provides ample opportunity for top quality investment, particularly now, given this market is at the beginning of a new cycle. As always, I suggest you stay within 2-12 kilometres of the CBD, but the specific suburbs, style and number of properties you buy will depend on what else you may be holding in your portfolio. Your next step should entail a review of your existing holdings, followed by a forward strategy to fill some gaps in the portfolio's composition.
I note your comments in 'Waiting to Buy’ on the timing of property purchases. What do you think about using RP Data’s new tradable house price index to provide a broad indication of a good time to buy/sell in the Australian market?
RP Data’s new index is going to be a very useful tool in terms of tracking broad market trends and cycles, although like every data set it will have its limitations. Given that all direct property investors ultimately invest in a specific suburb and a specific individual property, there is no substitute for a considerable amount of pavement pounding and research on actual transactions that occur at your desired price point in a designated locale. This is key, because like our Australian economy, the property market is a multi-speed one, even in the same city. Similarly, the ratio of supply to demand also fluctuates from suburb to suburb, from one week or month to the next, and this may not be consistent with what the broader index shows. With all that said, I applaud RP Data, especially for the timeliness of the data release – something long overdue in the industry.
Deciding when to sell – part 1
How do you decide whether to keep or sell a property that isn’t doing very well at present?
This is a very common dilemma, especially when markets are somewhat flat. For a start, you need to understand that investing in direct residential property is a medium-to-long term strategy and it’s also a growth strategy, so I suggest you ask yourself the following questions:
i) How long have you had the property?
If it’s two years or less, it’s too soon to judge its performance under the current
flat-ish conditions, so hold fire a little longer.
ii) How has it performed growth-wise during the holding period?
You want the property to be outpacing growth in the wider local market. So if values have fallen, you want your property to have held its value or fallen in value less than the wider market. If it has been in your portfolio for five to seven years, you would be looking for some substantial growth – certainly not doubling in value just yet, but heading in that direction, taking into account the overall market easing of 5-10% nationally in the last year or so. If you are very concerned, consult an independent property adviser in your home city and have the property assessed from an investment standpoint.
Deciding when to sell – part 2
I am considering selling an investment property in the short-to-medium term. When do you think the best time to do this might be?
The golden rule is to sell when supply is low and demand is high and buy when supply is high and demand is more moderate. Having said that, conditions are rarely this transparent! Given the current state of play, if you don’t really have to sell and the property is a high-quality one, I suggest you hold it. However, if your circumstances are such that a sale is necessary, then selling near the end of winter/early spring is often a very successful strategy, as is the late part of summer or early autumn. Markets are usually starved of supply and a little more pent-up buyer demand has accumulated at these times.
Note: We make every attempt to provide answers to readers’ questions, however, answers are of a general nature only. Subscribers should seek independent professional advice for more in-depth information that is specific to their situation.
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