12 Nov Renovator’s Dream or Financial Nightmare?
It’s a widely accepted fact that Australians love a good renovation. In recent times, it has become increasingly popular with the introduction of TV reality shows such as Channel 9’s The Block and Channel 7’s House Rules, attracting millions of viewers.
My own experience renovating my apartment over the last 3 months has been a real eye opener. With the décor of our recently purchased (first) home coming from well before my time, my wife and I completely tore apart most of the existing fixtures in favour of fresh tiles and shiny cupboards.
As a financial planner, I can identify two potential reasons to undertake a renovation:
- To improve your home, make it more livable and attractive.
- To improve the value of your home and obtain a better return on investment.
Many of the people we speak to regarding renovations tend to believe they can combine the two objectives, without much regard for the implications. So what’s the difference?
The lifestyle renovation
A lifestyle renovation is where your goal is to make your home beautiful. Because of this, you are less concerned with the cost of the works, and tend to purchase higher quality materials and make decisions that do not necessarily add value in the eyes of another purchaser. These renovations invariably take longer than expected. I can honestly admit that our renovations fit squarely in this box!
The investment renovation
Usually completed on an investment property, this type of renovation takes careful consideration of what changes will add value to the property or improve the rental income potential. Investment renovations are considerably cheaper because the exterior cosmetic is the main thing being judged by potential buyers or renters (the quality of the bench top or appliances for example, is not a deal breaker).
The overcapitalisation problem
Many people believe that they can get a positive return on the ‘lifestyle renovation’. That is to say that the value of the property will improve by more than the cost of the renovation. For a number of reasons, this is rarely the case. Overcapitalisation is where you spend money on something that does not add value to the property. This is typical of lifestyle renovations because the renovator will give closer attention to the minor and more costly details. A simple test one can use to determine if they are overcapitalizing is to ask the following questions:
If I were property buyer, would this renovation inspire me to make an offer? And/or
Would I be willing to pay more for the property?
There are a number of things you spend on which won’t get noticed when the property is on sale (or being rented). For example soft-closing doors in the kitchen may not get noticed, but they certainly are a nice touch.
Furthermore, if the renovation is lifestyle in nature, then it is likely that you’ll still live in the place for a period of time after the renovations are done. The value of the materials and hard work depreciate at a much faster rate when brand new – much like a new car.
There are a number of ways to value your property, but the primary way to do this is to actually sell it. The next best thing is to have your broker complete a valuation of your property (they’re sure to be quite accurate since they’re hoping to get their money back!). The benefit of this is the ability to access any equity you build for further investment. If the recent shock results on the Block are any indication, this does not always work in your favour.
When doing your renovations, I implore you to clearly outline your goals and set expectations from the beginning. In my experience, and from what I have gleaned from others in similar circumstances, renovations can seriously test our financial decision making. Most of us are astute enough to begin the project with a budget, but often fail to keep to it for a number of reasons. By clarifying your goals at the beginning and referring back to them, you will have a reasonable framework for decision-making, for example when it comes to decisions that are unlikely to add value.
About Reuben Zelwer
Reuben Zelwer established Adapt Wealth Management in 2011 to help time poor clients achieve financial freedom. For over 15 years, Reuben has helped professionals, executives, business owner and those approaching retirement make the most of their circumstances by making good financial decisions. Reuben’s professional practice is complemented by substantial voluntary work, which has included setting up financial literacy and savings programs in the local community.