It’s wise to spend money improving a property’s value but not if you spend so much renovating that you start to overcapitalise.
It’s a riddle for homeowners and investors everywhere: how much should I spend on a renovation to add value to my property? When will I start spending money I will never get back?
For renovation expert Bernadette Janson, warnings flash when people start talking about one room in particular. “Kitchens! It’s not unusual for someone to spend $40,000 or $50,000 on a kitchen, and there are very few properties that will give you a return on that.”
Overcapitalising is a dirty word in any renovator’s language. It’s like throwing cash at a problem that doesn’t exist or providing a service no one wants. It’s just a waste of money.
Property investment advisor Richard Wakelin has seen many people chase profits after spending money on things buyers or renters don’t want. “Very often, the cost of adding a second storey doesn’t translate to a higher [property] value,” says Wakelin, who is director of Melbourne-based Wakelin Property Advisory. “Creating large amounts of accommodation is not necessarily the way to maximise or add value.”
He says overcapitalisers often change floor plans and create unconventional designs that appeal only to themselves. “The [changes] tend to be shunned by large sections of the buyer and rental market.”
Janson, who founded The School of Renovating in Sydney, says anyone looking to improve their property profitably needs to know the market well. “Have a look at renovated properties on the market to get an idea of what your home will be worth when it’s renovated,” she says. “If you’re looking at adding a bedroom, you’ll understand that if you take [the property] from three to four bedrooms, you might increase value by $100,000. Is that going to be cost-effective?
“If you’re planning to stay forever, you don’t need to be so concerned about it because it’s a lifestyle decision. If you’re renovating to add value, then the renovations need to stand on their own.”
Wakelin also says investors looking to renovate, or even homeowners looking to maximise value, need to keep their property in line with market expectations.
“The best bang comes from relatively inexpensive cosmetic changes such as new carpets or polishing floorboards and repainting,” he says. “The other thing is replacing doors, cabinets in kitchens and bathrooms, and putting in new bench tops. There’s no need to put in expensive European appliances.”
What if you’re looking to buy an investment property to renovate and sell? “You need to buy property that has what I would call a ‘middle of the road’ level of improvement,” Wakelin says. “You shouldn’t be buying exotic, edgy and expensive renovations done by someone else. Often they become dated and obsolete. It’s about buying something that doesn’t require a lot of money being put into it.”
Janson says you should “always think long and hard” if you’re contemplating major structural renovations on an investment property. “It’s fine if you can move a wall or add a bedroom,” she says. “You can often turn big laundries into a second bathroom, which can be a plus depending on your market.”
Wakelin and Janson agree that investors are fairly safe if their renovation budget is between 5% and 10% of a property’s value. “You definitely wouldn’t be wanting to spend more than 5% [on a one-bedroom city unit] but I can think of situations where you’d go up to 10%,” Wakelin says. “The more expensive the property, the more expensive the renovation and the more valuable the land that it sits on. At the end of the day, it’s the land that’s driving value.”
Again, Janson says you need to keep an eye on your market. “There’s no doubt that just updating a tired property with paintwork, floor coverings and kitchen and bathroom updates done cost-effectively will not only increase your return, it will improve the quality of tenant that you get.”
For homeowners looking to maximise their selling price but avoid overcapitalisation, Janson recommends spending up to 2.5% of the property’s value on a kitchen renovation. “If it’s your own home, you can go up a bit more and not be overcapitalising,” she says. “Because you’re not doing it for profit, you have different criteria. You just need to manage your spending so you’re not blowing the budget.”
She suggests that you need to separate the things that will add to your lifestyle rather than increase profit. “A swimming pool is a lifestyle decision; it’s not a value-adding decision. People either love them or hate them.”
- Know the residential and rental market to see how far you should go with your renovation to avoid overcapitalising.
- Making inexpensive cosmetic changes are likely to produce the best return.
- A renovation rule of thumb is to spend no more than 5%-10% of an investment property’s value.