Manufacturing Equity In Your Investment Property
The one unique thing about property as an investment class, when compared with other types of assets, is that you have the ability to manufacture additional equity in property, and therefore, add more value to your investment portfolio. This is a powerful tool, used by some property investors, to increase a property’s value, and also to increase the potential rental income that can be achieved on a particular property.
Property is made up of a land component, as well as a building component, and in most instances, it is the value of the land that appreciates (or goes up in value), and the value of the building itself depreciates (or goes down in value). This is why, as property investors, we are able to write off the value of the building through depreciation. When a property has a significant portion of its value in the land, and the building itself is somewhat run down, then there can be huge upside potential for refurbishment, renovation or redevelopment, which are all methods that force more value into the property by increasing the value of the building component, therefore “manufacturing” additional equity into a site. But it is not as simple as it sounds. You need to be strategic about how you can use this strategy in your property investment portfolio so it delivers the results you desire.
Refurbishment involves working within the existing building structure and updating or replacing areas in the property that add the most value. Generally, this involves the kitchen and bathroom, although street appeal, paint and outdoor areas also have an impact. Many people can perform this work themselves, or with the help of basic trades such as painters, plumbers, tilers and cabinetmakers. This is usually lower cost building works, but the value uplift can be $2 for every $1 spent – sometimes more.
Next is renovation, which often involves a refurbishment as well as a structural change to the property such as an extension or addition to the existing dwelling such as adding an extra bedroom or extending the living. This is a lot more involved as generally, you will need a plan of the work proposed (prepared by an architect or draftsman), building approval, and sometimes development approval from council, to undertake structural changes to a property. Unless you are a qualified tradesperson, it is advisable to use qualified builders who provide home warranty insurance cover for this type of work, in case something goes wrong in the process. Obviously, the cost of this type of work is greater than refurbishment, but structural additions can significantly improve the value of a property – providing it is in the right location and providing the property appeals to the right target market.
The final way to manufacture equity is through development. This is a strategy that carries the highest level of risk, involves the most work, but also comes with the highest potential reward. When you develop a property, it means you demolish the existing building and replace it with something new which is usually of a higher and better use. For example, you may demolish a house and replace it with a duplex or 3 townhouses. The site selection for this method of manufacturing equity is critical because you need to consider, among other things, location, market demand, council restrictions (such as zoning) and maximum allowable density. I have seen many “mum and dad” developers buy a property believing they can undertake a development, only to be told it is not possible. In this area, you need to work with an experienced team who can guide you and ensure that the project is possible and feasible so that your investment strategy is able to be implemented.
There are some fundamental steps involved in ensuring you can manufacture equity in a property, regardless of whether you intend to add value through refurbishment, renovation or redevelopment, to ensure you lock in your returns. These are as follows:
- Choose a location that has wide price disparity between unrenovated or old and renovated or new properties.
- Ensure the unimproved land value makes up a significant portion of the purchase price of a property and check council mapping to find out what you can and can’t do on a particular site.
- The layout of the property should reflect the strategy you are following. If you are only refurbishing a property, ensure the layout is already suitable. If you are renovating a property, ensure you get professional advice on the existing structure, so you know what you are already working with.
- Understand your costs. It is best to get professional advice on actual proposed costs before you start so that you do no overcapitalise and spend more than what the property will be worth upon completion.
- Upon completion, it is always a good idea to get your property re-valued. This enables you to “lock in” the additional equity you have created, which can often then be used towards the deposit for your next investment property, depending of course on your individual circumstances.
So, don’t assume that all property investment strategies are a ‘set and forget’ type of investment. Look for opportunities in your existing property portfolio, or seek out properties that will deliver additional returns for you, with your next purchase. The power that we have to unlock the hidden potential in many properties, provides enormous opportunities for those who wish to force more value into their portfolio, with a more aggressive property investment strategy.