What is overcapitalisation, and how can you avoid it in Melbourne property?
Overcapitalisation is a risk for any Melbourne property investor. This is a situation where you make renovations or additions to a rental property that cost more than the value that is added to the home.
Think spending thousands of dollars on expensive bathroom fittings when the bathroom has structural issues, or conducting such expensive renovations that your property’s value extends well beyond what buyers would pay to live in your suburb.
If selling a house for profit is your goal in the long term, then overcapitalisation is something you have to think about any time you renovate. Here is who it can impact, and how to avoid it.
More renovations can mean more risk
An upswing in renovations theoretically means more people at risk of overcapitalising their investment property, and recent Housing Industry Association research shows that we are spending more on our homes. Over 2015, renovations activity went up by 4.5 per cent; last year it increased by 3.3 per cent.
Detached houses that are more than 30 years old are emerging as the focal point for renovations.
While this is set to slow to 0.6 per cent growth in 2017, the market nationwide is still worth more than $33 billion. In particular, detached houses that are more than 30 years old are emerging as the focal point for renovations and additions.
So we have identified what overcapitalisation is, and the scope of who it can impact – but how can you avoid doing this to your own rental property?
How to avoid over capitalisation
One of the first and best things to do is to talk to your local real estate agent, or your property manager. They know the local market, and understand what will effectively add value. For example, there could be strong demand for homes with two living areas, necessitating a bedroom renovation rather than focusing on, say, a landscaping project.
Also conduct market research on your suburb and neighbouring areas, to avoid overcapitalising beyond what buyers generally pay. For example, CoreLogic figures show the median value in Pascoe Vale is a bit over $750,000 – overcapitalising too far into seven figures might see you lose money. Finder also recommends spending no more than 10 per cent of your home’s existing value on renovations – so a property valuation could also be worthwhile.
If you’re yet to buy, it could be worth looking at homes slightly below market value that have potential for significant renovations as well.
There are many variables, and they will change depending on what you buy and where you buy it. To make sure you’re renovating a rental property right, get in touch with the experts at Nelson Alexander.