Investor Mistakes: Overcapitalizing on your renovation project
Disclaimer: Nothing is this article is meant to constitute financial advice of any kind, and is the opinion of the author only. Seek professional advice before making any financial decision.
Overcapitalizing on your renovation project
By James Upton
One of the biggest mistakes I see investors make is overcapitalizing when renovating properties, both trading and within their buy-and-hold portfolio.
And yes, I am guilty of falling into this trap over the years as well.
It is funny because everyone is so objective when it is not their property, however, the minute they have ‘skin in the game’ the emotional attachment seems to set in. Suddenly, the matter-of-fact demeanour of sticking to the budget can morph into a splurge here and a splurge there when it is their own property.
It is not so much the extra $20 for a light shade that matters, but when you add up 10 of those throughout the house that is a total of $200 extra.
Now this is fine if having a slightly nicer light shades increases the sale value of the trade or increases the rent of a hold, but in my experience, generally these little additions to the budget don’t do either.
The main thing they do is take away profit from your bottom-line. You have effectively lost $200 and the only thing you have to show for it is marginally nicer light shades.
I like to work off a 3 to 1 rule when I am doing a renovation for either a trade or a buy and hold property.
It is not an absolute steadfast rule, but more often than not it works out. Basically, if I am spending $1,500 on putting a fence up across the front of the property, I want to see a return of $4,500 either in profit when I sell it as a trade or equity when it gets valued as a hold.
It is a cliché but as this is a business it all comes back to ROI (Return On Investment). The only exemptions to this rule are if it is going to dramatically decrease maintenance going forward for a buy and hold property or in regards to a trade if it is going to make the property sell faster.
Even then it may not be worth doing during the renovation but it could be a point of negotiation in the contract to get it over the line. For example, I don’t regularly put heat-pumps in my trade properties. When I go back to my rule of thumb, they are $1,800 approximately and I do not see $5,400 of extra profit by installing one. However, the last South Auckland trade I did the agent mentioned that the purchasers loved the property but one of their priorities on their check list was a heat-pump. To get the deal across the line I said that if they could go unconditional on the contract, I would have a heat-pump installed for them by settlement. I saw this as a win-win scenario as they got an extra appliance they wanted for their home and I was able to get the property sold and move onto the next one.
One of the most important things when working out how much to spend on a renovation and the quality of items you are fitting the property out with is knowing your target market.
Who is your buyer in that market, at that price point? Investor? First homebuyer? Second homebuyer? Are you at the $600,000 price point or $2.5 million? Or if it is for a rental property, what is the standard that tenants expect in that area, at that price point. A family paying $450 PW rent is going to have completely different expectations to a family paying $2,000 PW rent. Odds are they are in completely different socio-economic brackets. This way, by knowing your buyer or tenant you are able to cater for them to the highest standard that your ROI will let you. Any more and it is money out of your pocket, any less and they be swayed to go with the competition.
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