Late one night I received an urgent email from one of my clients; let's call her Mary from Melbourne. As a fairly new investor, she was very distraught and worried that she had made a huge mistake in renovating her recently attained investment property before leasing it out (a 2 b/r unit, purchased for $135K).
Blogger: Kevin Lee, founder, Smart Property Adviser
A Tough Beginning - common concerns about renovating
Mary's other concern was whether or not she would be able to depreciate the renovation costs. The renovation included repairs to the carpets and vinyl flooring, and the installation of a heating/cooling system.
My client was worried that the costs associated with this renovation would only be added to the cost base of the property and not be classed as repairs. She was fearful that she wouldn't be able to depreciate any of it in the first year. And therefore unsure about whether or not she should 'bother' getting a depreciation report done.
These concerns are not uncommon - amongst both new and experienced investors, so I will share my professional opinion & advice for those readers experiencing similar concerns.
First let me list the FOUR primary reasons why we renovate:
1. To improve the desirability of your property to prospective tenants
2. To attract good tenants TIP - treat your tenants fairly & they're much more likely to take care of your property
3. To achieve the highest rental return possible for the property
4. To increase the value and therefore your equity in the property
Repairs & Replacement
My understanding from 16 years as an investor is that 'repairs' are able to be written off in full in the year the expense is incurred.
As well every item 'replaced' which has a value under $300 is also able to be written off in the year the expense is incurred.
You'd be surprised how many individual items cost $300 or less! You must speak to your accountant about write offs and repairs!
Owning a property less than a year
While many pundits (and some accountants) state that you should not renovate until after you've owned the property for 6-12 months
- this is not necessarily 'the right thing' to do if you're in the market looking for cash flow positive properties.
In lower socio economic areas, many of the properties I inspect for clients (I'm a licensed Buyers Agent as well) are in a state of disrepair through years of the worst double whammy for an investor: "bad property management" and "poor quality tenants".
When I'm out inspecting on behalf of clients, I'm often told by agents that:
* "the property has a good long term tenant" - this means they pay the rent; and
* that the property is "under the market rent" - this means the agent is lazy and the "good long term tenant" is there because they're paying up to $50 a week below market value.
In such circumstances, I recommend that renovations are absolutely necessary to provide a better quality rental option, attract a higher quality tenant and therefore a higher rental return.
TIP - don't disregard 'lower socio economic' areas as some of these locations are currently providing great rental returns. Just know what you're doing!
I always recommend that my clients obtain a depreciation schedule; therefore any renovation costs they incur are spread out over the longer period & accounted for.
All investors have to wear this ATO idiosyncrasy when it comes to renovations and depreciation; live with it. For example, this year I will be renovating each of my Queensland investment properties with new kitchens, new bathrooms, new carpets to bedrooms and polished porcelain tiles throughout.
Most of all, these renovations will add to the cost base/depreciation base. And substantially increase my rental returns!
As I told Mary from Melbourne, "please don't knock yourself out simply because you aren't able to claim all of the renovation costs in the first year - that's why we obtain a depreciation schedule". This dilemma is just an unfortunate part of life as an investor.
A Happy Ending - just recently I received a reply email from Mary. She was ecstatic and proudly boasted images of that same recently renovated property.
It was crystal clear that her decision to renovate before tenanting was the right choice.
She couldn't wait to tell me that the property is now leased to a lovely young lady for $265 a week.
Note well - remember that Mary bought the property for only $135k to begin with, so that's a great rental return for some minor renovations.