When Does Value-Add Become Over-Capitalisation?
A vast number of investors target properties that they can improve. Whether the inspiration comes from television shows (that make it look oh-so-easy), or a course with a firm framework, some investors get it horribly wrong.
Determining whether you are actually suited to delivering a value-add to a property should be the first assessment conducted. Some prospective investors struggle to make the first appointment to my office, and after weeks of rescheduling and postponing the meeting, they finally make the meeting and then suggest to me that they are looking to do a project.
“Why would you be confident that you could manage a project when your schedule has barely allowed you to meet me for an hour?” I ask them.
Not all investors are suited to projects, and not all property investments require improving.
Sometimes the best property assets are those that require no work, attract a great tenant immediately, and grow organically due to favourable capital growth conditions.
Despite the epic fails, the project overruns with cost blowouts, and the investors who find themselves out of their depth with a challenging renovation on their hands, I have also witnessed some incredible transformations on shoestring budgets. Often the best projects are those handled by someone with experience, and in all cases, the successful value-adds are conducted with a firm plan and a prior insight into the opportunity for the value-add.
Recognising where a cost-effective transformation can deliver a punchy result is often the key to success. Some investors can apply a bathroom makeover and a kit-kitchen installation on a budget under $10,000. Provided the configuration of the rooms in question don’t require full remodels, a savvy investor’s work can pay off. We recently assisted a client with the quest for a house he could purchase well and ""clean up."" A well-located, character home that could only be described as ""a hoarder’s house""caught his attention and he could see past the mess and extreme-clutter. Improved superbly with polished floors and gloss lacquer, and updated bathroom and kitchen features, the clean-up itself covered a large portion of the transformation.
The degree of works intended is another critical determination for any keen renovator. I often ask specific questions to gauge how much work a renovator is actually prepared to take on. People often say “We can do cosmetic work” but for some, cosmetic only applies to painting and interior dressing and decorating. Many who declare that they can renovate but won’t tolerate any restumping don’t comprehend that the restumping is less confronting than some of the other tasks that they could be considering. “Moving walls” is a common throw-away line, but the ability of the renovator to move walls will always be questioned when load baring concerns, council regulations and practicality is taken into account.
Undoubtedly one of the most valuable discoveries a renovator can make is to be able to spot when a required change is likely to be more expensive than the value it will offer post-renovation. Some of these expensive fixes can include:
- Invisible issues (such as plumbing, electrical and structural). Investors who find themselves rewiring an entire house when the concept itself was not contemplated can regret the purchase in the wake of sinking $10,000 that was not allocated to the project initially.
- Compromised floor plans. If the ultimate plan is to move walls and relocate wet areas, the investor needs to calculate the cost of doing so. Paying an extra $100,000 for an alternative property with a better layout may seem extreme, but if the renovation scope sits around $300,000, the extreme decision may win over.
- Hidden issues behind a cheap, glossy renovation. Most vendors will take counsel from their agent when they sell a property and it’s not uncommon for a cheap gloss-over to be hiding some more serious issues (such as timber rot, rising damp, termites etc).
- A freshly renovated property that should have been restumped before the renovation took place. While restumping quotes may come in sub-$15,000 for houses, it’s the work required afterwards that can hike up the costs. A restumping effort can often leave a house appearing as though it’s faced a cyclone, and retiling, re-sheeting plaster, painting and sorting out the adjusted position of cabinetry etc can add a lot more items to the workflow than the mere activity of restumping.
When considering a project, renovators should ensure that they are confident, equipped, have a firm plan and have a very clear understanding of the condition of the property and the opportunities for improving it. Adding value is one thing, but over-capitalising is a waste of valuable resources and it runs counter to the option of just purchasing a well-located property in sound condition that will deliver a passive growth result.