Renovating for profit
Many investors seek to add value to their properties through renovations, but once you look at the numbers, it doesn't always add up.
Blogger: Cam McLellan, director, OpenCorp
Lots of people ask me about renovations and why I don’t renovate.
This is the smallest development type, but just because it’s the smallest development type does not mean that it’s the best place to start.
If you own or buy a house, and want to add value to it, one option is to renovate. If you renovate for yourself you’re an owner, which has different taxation laws applicable than that of a developer. If you renovate for profit, you are not a developer. You are what’s known in the industry as a flipper. I’ve renovated many houses in my time and have found it to be a waste of time and effort in most cases. Any profit I made was largely due to the market increasing rather than the value I added through the renovation.
Here’s why: Say you buy a property for $500,000. Let’s look at what costs you'll have and what your break-even margin will be.
Purchase and renovation costs
Stamp duty: $25,000
Basic cosmetic renovation: $25,000
Interest during holding period (12 months): $25,000 - I’ve used 12 months as the holding period for this example to ensure the least amount of capital gains is paid. You will pay a capital gains tax of 25 per cent on profit rather than 50 per cent if held for a period longer than 12 months.
Total cost before selling: $575,000
Agent's fee: $15,000
Break-even point / total cost: $595,000
So in this instance I’ve purchased a property in a market that costs initially $500,000 and just to get my money back I have to sell it for nearly $100,000 more than I purchased it for. Think about that, I need to sell it for $100,000 more than the purchase price when all I’ve really added is $25,000 worth of actual value to the property.
So let’s look at the highly unlikely scenario and imagine the property fairies were very kind and I managed to sell it for $150,000 more than I purchased it for. Let’s see what the actual profit will be in my hand.
Total cost: $595,000
Sale price: $650,000
Minus 25% capital = $13,750
Actual profit = $41,250
So my equity contribution to buy the property at an 80 per cent loan-to-value ratio is $100,000 + $95,000 in additional costs = $195,000. Remember that the profit in this highly unlikely example is $41,000 on a $195,000 equity contribution. This is a return of approximately 20 per cent. Now some people would say 20 per cent return is fantastic, but the question to ask is: Is renovation worth the risk? I will be blunt here. For the last decade I’ve achieved above 20 per cent annual return on my money investing in my developments and I’ve achieved this with much less risk than comes with renovation. There are much safer ways to make money when it comes to development.
Now let’s take the TV show The Block in 2014 as a good example of what happens when buyers are taken from the market.
These figures are not profit they are simply the price that was achieved above the reserve. I’m very sure the profit was a lot less on all of these sales.
1st property - $335,000 above reserve
2nd property - $310,000 above reserve
3rd property - $40,000 above reserve
4th property - $10,000 above reserve
5th property - $10,000 above reserve
The first thing you should know with these figures is that not all costs or taxes have been taken into account, which is why the amounts shown are not net profit. The other advantage that they had and you won’t was a TV show to help market the property for sale.
Looking at the prices you can see in any area there are only a certain amount of buyers in the market at any point in time. Once the first two buyers had purchased their properties there was no interest at that higher price point. So, if you are trying to buy a property and lift it to a higher level of class and price point through renovation, you need to be very aware that if you can’t find a buyer, you may have to drop your price drastically to get a sale. This means that both profit and loss projections need to be considered before renovating.
• Renovation can be time consuming.
• It can also put great strain on relationships and lifestyle.
• Fast turnaround meaning you can get in and out.
• Your time invested into work can reduce costs.
• No council planning if only minor renovations are carried out.
I have, of course, used round numbers in my above example so things may differ slightly here or there, but hopefully I've answered those who wanted to know why I don't renovate. If you've got any questions for me then don't hesitate to get in touch.