Renovation Feasibility: Just because it looks good, doesn’t mean you will profit

With Stafford having been the darling of the interstate property investors set for the past 18 months or so, due to the large lot sizes and the relatively easy ability to renovate the old timer houses.  It is worth reviewing whether renovating for profit is still a viable option.

Home renovation and DIY is a huge industry in Australia. The proliferation of home renovation shows has both demonstrated and contributed to this phenomenon.  For many, the goal is to improve their own home, for their own purposes; but for others, the goal is to increase the value of an investment property for the purposes of creating equity or a cash profit upon sale.  Can you, however, really make a profit with renovation?  And if so, how do you work out what is going to be profitable and what is going to be a whole lot of work for very little return?  Let’s take a closer look.
Lots of people undertake improvements on their own home so that they can benefit from those improvements. Who doesn’t want a brand spanking new kitchen to enjoy? Who doesn’t want that lovely outdoor decked entertaining area? There’s absolutely nothing wrong with splashing out to your heart’s content on such improvements and forging ahead without calculating the financial feasibility and expected financial outcome of the improvements where your sole aim is to provide enjoyment to yourself and your family.  So long as you understand that that is exactly what you are doing.

Ever heard the term “over capitalised”, when you spend more money improving a property with out getting an increase in value of a property to the same value.

We are going to consider those who are looking to do renovations that will result in financial gain, either through revaluing a property to access equity or selling a property for profit.  In this case, spending time on the renovation feasibility is a must and can really save you a LOT of work in the long run.  Just because a house is run-down or can be improved, does not necessarily mean that the project will stack up as a money making venture.  When you are renovating for profit you need to be adding value much greater than the funds than you are expending.

Just because you can doesn’t mean you should.

This is where many people come unstuck in their renovation project. You see it’s not about how beautiful the property looks at the end, as shows like ‘The Block’ may have you believe; it is all about the numbers. These are numbers that you can and must assess before you take on a project or buy a property.

These are the 7 key numbers that are vital in understanding when calculating your renovation feasibility:

• Purchase Price — This is the price that you pay for the property.
• Buying Costs — These are the costs associated with the actual purchase of the property and include things like loan establishment fees, mortgage broker fees, buyers agent fees, legal costs, stamp duty.
• Renovation Costs — The cost of the actual work, both materials and labour to renovate the property.
• Holding Costs — The costs associated with holding the property during the renovation and up to the sale (if you’re selling). This includes things like bank interest, council rates and charges, water, power, gas.
• Selling Costs — These are the costs associated with selling the property and include legal fees, agent fees, advertising and any other costs associated with the property sale.
• Profit Margin — This is how much money you want to make from the project.
• Expected End Value or Sales Price — This is the expected value that the house will have or achieve at sale after the renovation has been completed.

You see it is not as simple as buying a house for say $500,000 spending $50,000 on a renovation and selling it for $600,000.  Then claiming you made a $50,000 profit.  In fact your profit (if any will be significantly lower).

Lets walk through an example of a renovation feasibility and you will see that the differential between your purchase price and your end sales price needs to be quite significant in order to account for all of the costs in between.  This is where you will really start to see that turning a profit from renovating is not as easy as it sounds.

Let’s take our example property, which is a real deal that was considered recently.  A great property (in need of some attention) in a fantastic location just crying out for renovation.  This feasibility will determine if it’s worth looking more closely into the project.  If we can get the numbers to be someone in the ballpark of where we need then we’ll undertake more detailed analysis.

So what you can see here is that if you buy the property at $475,000, spend 6 months or so renovating, ensuring that you spend only $40,000 on the renovation then you must be able to sell the property for $633,000 in order to achieve your aim of $50,000 profit.  Now that may not be easy.

Some key questions to ask:

• Do renovated properties in this area achieve $663,000?
• If so, can you renovate it up to this standard required for your allocated $40,000?

So here is where it just comes down to numbers.  Will the property sell for the price you require, will it cost what we estimate, will it sell quickly or slow.  There can be no emotion in this decision, just the numbers.  Emotion is not your friend at this stage of the process.

So is honesty. If the sales price can not be achieved, then the answer is do not proceed.

Once you lay the numbers out in front of you like this for any property you are looking at then you’ll be able to assess if the project really can make a profit for you and therefore you’ll become a lot more ‘choosy’ when it comes to selecting your property in the first place or deciding whether to renovate a property you already own for profit.

You can also use this exercise to run some ‘what if’ exercises:

• What if I could buy the property for $30k less?
• How does this affect my end sale value?
• What if I could renovate for $30k instead of $40K?
  

You can run some scenarios and be clear about the maximum amount you can pay for a property to make your project work—and hopefully stick to that number and move on from the projects that look like they’d be great but just don’t stack up!

When it comes to selecting a property that may be a renovation option. It is important to speak with a real estate agent that understand what a renovator is looking for and also what the market can achieve after the renovation.  Justin Hicks from Hicks Real Estate at Everton Park is one such agent.  In fact Justin has experience as a builder so can easily identify what to look for in a renovation project.

So talk with Justin if you want to find the right renovation project in the Stafford and Everton Park region.

There are so many ‘renovators’ delights advertised but reality is that many of these are properties definitely in need of improvement but they won’t necessarily make you money.

Remember: Just because it looks good, doesn’t mean you will profit!