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Can I make money renovating?

December 2, 2014

Neither over-capitalise nor under-capitalise

Direct property investment has never been a passive occupation. Unlike shares or bonds, one can’t set and forget for years on end. Tenants must be found, served and replaced from time to time. Checking in regularly with the managing agent should be an ingrained discipline to maintain an even keel and avoid surprises.  And, every few years, the property will require renovations.

With renovations, the timeless quandary for landlords is finding the right path. They want to avoid over-capitalisation – wasteful spending that doesn’t deliver sufficient return to justify the outlay. But wise investors also know that under-capitalising can be just as costly. Skimp on maintaining a property and eventually you’ll struggle to find and/or keep a tenant or maintain the rental yield.

The bar on what tenants expect has undoubtedly risen in recent years, mostly as a result of a surge in new apartments and town houses replete with shiny mod cons and contemporary styling. The boom in renovation and lifestyle shows is also a factor.

To bling or not to bling?

Whether an owner of an older-style property should consider trying to out-bling the new developments to remain competitive depends on the extent of the threat. The intensity of development varies from suburb to suburb.  The form of the development also matters. Prospective tenants tend to split into distinct category: those in the market for a house and those in the market for an apartment.  So if development in your area is skewed towards apartments and you own an older-style house, the threat is less acute than if you own an older-style apartment.

How costly is it to attempt to match this level of amenity in new property, and is it worth trying?  A designer-level renovation is a big job. It often includes a new kitchen replete with prestige oven and cooktop; a new bathroom including wall and floor tiling; new carpets and the polishing of floorboards; new fixtures and fitting and repainting.  If the property is a house, it might also include skylights, exterior painting and the addition of a deck out the back.

Be prepared to pay $50,000-plus to undertake this project in its entirety – even more if you are considering moving walls to create bigger rooms or open the house onto the garden. But it may be worthwhile.  It’s not unusual for this sort of investment to support a rise in rent of 40 per cent or so and for every dollar spent on renovation to increase the value of the property by two dollars.

Note that the key to success is focusing on renovations that are visible to tenants (and potential buyers down the track).  Avoid significant unseen structural work such as rewiring, fixing roofs and restumping. Tenants aren’t willing to pay more rent for these type of improvements. Indeed, prospective investor should ensure they avoid buying properties that require this sort of work. Try to buy from someone who has done the hard yards already!

Notwithstanding the likelihood of a good return from a designer-level renovation, pause for thought before going this way.  $50,000-plus is a sizeable commitment for many investors and costs can balloon as complexity increases or if there are delays. Success is dependent on the initial design vision and the skill of the tradespeople.  On occasion, the outcome doesn’t deliver the expected financial uplift, either because of poor execution or misjudged decisions about prevailing tastes.  And there are some properties that just don’t lend themselves to avant garde styling.

Less may be more

Indeed, less is more is often the optimal route with renovating older properties.  Recognise that although there is a significant pool of tenants who crave chrome, frosted glass and wood finishes, it really isn’t to everyone’s taste. There are many tenants and homeowners who prefer a property with a more timeless or even retro feel, especially if it is going to cost them less to rent.

For this audience, it’s about freshening up a property, not transforming it.  So repaint, recarpet and polish the floorboards. Put up new blinds, fix or install flyscreens and update the light fittings to allow low energy bulbs.  Replace the dirty oven, but forgo the prestige German brand. A new mid-priced stove and range hood is fine. Keep the kitchen cabinetry but consider new doors and handles.  Attach deeper bench tops over the old ones to increase work surface area and add a splashback.  Re-grout the tiles in the bathroom and polish up the 1960s bath.  Consider adding split-system air-conditioning if previously missing.

Depending on the starting point and the size of the property, a modest renovation can often be done for as little as $5,000 and typically for between $10,000 and $20,000. You tend not to achieve the same magnitude of uplift in rent level and property value as the designer-level renovation delivers, but with rents often jumping by 20 per cent or so, the percentage return on the outlay may well be superior.  Moreover, less ambitious renovations are also less likely to over-run, go wrong or be rejected by tenants.

Good property managers know what the pool of renters is looking for. And they also use the best tradespeople.  So if your property is tired, book a makeover meeting with your property manager.

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