‘Manufacturing equity’: I’ve always found that term interesting!
We’ve all seen the stories of the quick gains that can be created by renovating a property. And there’s no shortage of consulting firms out there that will gladly take your money to help you do it.
Renovating for profit is often dressed up as a sure-fire way to build wealth, but many facts about the fundamentals of investing and the renovation process are regularly overlooked.
I’ll get into the nuts and bolts of why the financials rarely work on your average renovation project in a moment, but let’s first address the biggest reasons you should exercise caution with setting out to buy a do-er-upper-u.
Short-term gain
TIP #1: Renovation projects limit your potential property options to those addresses close to you.
Think about it – you buy a property for, say, $500,000 and in a best-case scenario spend $50,000 in the hope of adding $100,000 to the value. In my experience, adding two-dollars value for every one-dollar spent would be a rare outcome, but let’s just say it was possible.
Let’s say that the particular year that you had your finances in order to make this $500,000 purchase was 2013 and that your home town was (conveniently) Australia’s best performed capital city – with 12.3 per cent price growth in 2013, that city is Perth). To satisfy your urge to get your hands dirty and deal with logistically challenges, you obviously need to buy locally. So, you complete your $50,000 renovation project during the first half of 2014. But, hang on, the market has quickly deteriorated and your total outlay of (now) $550,000 is suddenly only worth $500,000!
With the benefit of history, we now know that Perth’s market commenced its decline in late 2014, continued for 3.5 years, meaning your $550,000 outlay has reduced in value to $450,000.
What first appeared as a fail-safe way to ‘manufacture’ equity produced a capital loss of $100,000 and it still looks like being quite some years yet before any meaningful growth is likely in Perth.
Property markets move in and out of cycles all the time. Every market does. Renovators are often totally oblivious to this because their primary focus is on the bricks and mortar.
If the urge to don the tool belt wasn’t restricting the location selection, that same $500,000 in 2014 could have been used to purchase a quality property that needed no renovations in metropolitan Hobart. 3.5 years later, that property would have increased in value by 40 per cent to $700,000 with a further period of double-digit growth still to come.
Market fundamentals
TIP #2: For lifelong wealth building, it’s the MARKET, not the property, that generates the biggest gains.
I’ve studied property markets across the nation and, unless your full-time profession is as a (successful) property developer, the key to making the most profit isn’t by getting your hands dirty. The most important element is making sure you’re holding an asset in a market that has the right fundamentals for price gains.
Step ONE in making all good decisions starts with reviewing 100 per cent of your options. As a property investor, those ‘options’ are the property markets of 550 local councils across Australia’s 8 states and territories.
Can you imagine an astute share investor limiting their stock selection to buying shares in the company that they bank with? Astute property investors appreciate that it’s not the bricks and mortar that grows; they remove the blinkers and have a national market focus.
Imagine if you lived in Sydney or Melbourne right now. At best, flipping houses in a flat (or declining) market will provide no capital gains benefits beyond a dollar-for-dollar increase based on the cost of the work completed. All of that personal exertion for no gain!
The key to making money in real estate is identifying markets with good fundamentals. This includes a location that is yet to commence its growth cycle, a high degree of confidence that the economy of the city in question is destined for sustained improvement, controlled housing supply (current and in the pipeline), and the median dwelling price is affordable to the masses.
Hard work, but no guarantees
While the long hours and stress of renovating make for great television drama, they shouldn’t be underestimated by the average punter. ‘The Block’ is an example of UN-reality TV.
The contestants on this game show do need to work hard and compete, but they’re part of a bubble-like environment that shields them from many of the stresses you normally need to handle during a reno project.
Contestants are handed the property and council approvals are already in place. They’re given a budget and a stock of available tradespeople. Their materials and supplies are acquired at heavily discounted prices and producers come to their aid as required to ensure the job gets done properly. Finally, they’ve got the benefit of a (national) marketing campaign that consists of 3 months prime-time TV and general media exposure. UN-reality!
Renovators shouldn’t under-estimate the logistics of fitting in your real job and day-to-day life with either completing the reno project yourself or managing others (and their own profit margin) to do it on your behalf.
Expect delays, frustrations and the unexpected during the project.
The only guarantee you’ll have is cost, uncertainty and hard work!
Not all costs are included
In addition to materials and external labour costs, the biggest (yet often under-estimated) cost is the owner’s time. For every hour spent on the tools or organising others that’s an hour that you’re not earning an income from your core business.
From the time that the owner settles on the site until the eventual completion of the project, interest costs will be accruing on the loan while no rental income is being received. A $500,000 initial purchase and a 6-month renovation equates to around $15,000 interest.
In addition, there are the buy-in and buy-out costs associated with agents and conveyancers as well as stamp duty and other administrative and statutory outlays.
Finally – the ATO will get their fair share, too, with capital gains factored into the mix.
Even the most ‘successful’ project rarely yields a stunning result once all expenses are allowed for.
Why bother?
Sure, we all know people who have completed a renovation project and claim that they profited two-dollars from every dollar spent. But, without closely examining the books, it’s anyone’s guess as to whether all of those aforementioned costs were properly accounted for.
Ask yourself what contributed most to the alleged profit. Did that $50,000 (total) renovation outlay really increase the property’s value from $500,000 to $600,000? Or did the market itself move by 10 per cent? If it was the latter, then that $500,000 initial purchase will have increased in value to $550,000 without the owner having devoted all of that valuable time and hassle.
For me, to give my hard-earned money the best potential for growth begins with reviewing the fundamentals of Australia’s 550 city councils, not the tool belt! Finding that ‘next Hobart’ is my primary objective. I then focus on identifying a low-maintenance, structurally sound property within certain pockets of that chosen city.
Then, as they say, ‘set and forget!’
Repeating this process can result in owning three properties in different locations for as little as $500 per month.
At some point, work will need to be carried out on every room in every property. But, if it’s not broken don’t fix it! The time that I want my property looking the best is in preparation for sale. On a case-by-case basis, I’ll then do a proper feasibility study on whether spending one-dollar will add two-dollars in extra value.
It doesn’t sound sexy because it’s not – it’s investing!
If you really want to get your hands dirty, maybe a better way to scratch that itch is to renovate your family home.
Propertyology is a multi-award-winning buyers agency and (national) property market research firm. As Australia’s only company to correctly predict Hobart’s remarkable turnaround before the current boom, the firm’s success includes being a finalist in the 2017 Telstra Business Awards and 2018 winner of Buyers Agency of the Year in REIQ Awards For Excellence.
