Don’t overcapitalise if you build or renovate

Flippers, fixer-uppers or buy-to-builders: do you fall into any of these home-buyer categories? Then pay attention – because there are pitfalls. Whether you’re applying for a  building loan because you’ve found the perfect spot to create your dream house, or you’re looking to buy a fixer-upper at a bargain price and renovate it, either as your family home or to sell it for a profit, you need to start off by doing your sums. After buying a great plot or a bargain house, it’s easy to overcapitalise on building or renovations.

Simply put, overcapitalising means that you spend more on buying the house and renovating it, or buying the land and building the house, than the property ends up being worth. When you eventually decide to sell the house – whether it’s a few years down the line or if you’re flipping a home for profit – it may not sell for a high enough price to recoup all the money you’ve invested.

Here are some factors to consider:

You might put off potential buyers

Over-the-top upgrades do not always mean a higher price when it comes to the resale of a property. Extensive renovations could make a property too expensive for the area, turning away potential buyers. Those who can afford the house could see the area as ‘too downmarket’, while those looking for homes in that area have chosen the location not only because it’s in their price range, but also because they’re attracted to its ‘local character’. An overcapitalised house is out of their price range and unlikely to align with the character that attracted them to the area to begin with.

Quirky alterations that cater to your personal taste, such as a sauna or home cinema, also don’t necessarily enhance the resale value of your property. Prospective buyers could be turned off, knowing they will need to spend a lot reconfiguring the property to suit their needs. The rapid advance of technology also means that any fancy fixtures and design elements you add to a house could go from ‘cutting-edge’ to ‘outdated feature’ much quicker than before.

Don’t cut corners on quality workmanship

Unless you’re a professional builder or renovator, avoid doing the renovation or building work yourself. A DIY job – whether it’s building, painting, tiling, electrical connections or plumbing – is often messy and easy for buyers to spot. Clumsy DIY renovations may actually lower the value of your property, so you could end up having to pay a professional to fix your mistakes anyway.

Talk to a local estate agent to find out how much you can realistically expect the value of the property to have risen by the time you sell it

When planning a building or renovation and applying for finance, make sure that your budget includes accurate professional contractor costs. Then employ the services of a qualified builder who is registered with the National Home Builders Registration Council to ensure quality workmanship.

Talk to your estate agent

Housing experts advise homeowners not to invest more than 25% of the market value of a property on improvements and renovations. Of course, market value is not necessarily the price you paid for it – that’s one of the reasons people buy fixer-uppers, after all. So, before buying a property and planning extensive renovations, make sure you know what its current market value is, to work out what your maximum spend should be.

Talk to a local estate agent to find out the median price of houses in the area, what the local house price inflation trend has been over recent years, and how much you can realistically expect the value of the property to have risen by the time you sell it. You can then tailor the amount you spend on upgrades, so you don’t end up with a house that’s hard to sell because the asking price is too high.

Renovating for rental is renovating for tenants

Don’t fall into the overcapitalisation trap when you buy a property to rent out for income. A common mistake is to become too emotionally attached to your investment and renovating in a style that suits your taste. After all, you won’t live there – you need to create a fairly neutral style that tenants can adapt and make their own.

Although some renters may be dream tenants who treat your property as carefully as if it were their own, many aren’t

Often a simple locally made tile may be a better flooring choice than, say, expensive wooden floors, if the wood is hard to maintain. The tiles will be cheaper, and tenants will find them less trouble to keep clean. Equally, simple but durable bathroom fixtures and light fittings that are not easily damaged and keep doing the job they were designed to do for ages are a better choice than anything fancy but delicate, or hard to replace.

Something else to consider is that although some renters may be dream tenants who treat your property as carefully as if it were their own, many aren’t. Set a reasonable budget for renovations, based on the amount you will be able to rent the property for, and then renovate within that budget. Choosing fixtures and fittings that are durable to begin with, and not too expensive to repair or replace if they are damaged. If you overcapitalise when renovating a rental property, to recover your investment you will need to charge a rent that may make your place hard to let.

Whether you’re buying to build or renovate, you must first work out how much the property is going to be worth, then subtract the cost of buying the property – and the amount left will be your potential budget. But if you spend that whole amount on building or renovations, you’re only going to break even. To make a profit out of the property, whether in the short or long term, you must spend only a portion of that amount on the project.