Renovation Feasibility: Just because you can doesn’t mean you should

 

renovation

Home renovation and DIY is a huge industry, not just in Australia, but in many countries around the world. The proliferation of home renovation shows has both demonstrated and contributed to this phenomenon.  For many, the goal is to improve their own home, for their own purposes; but for others, the goal is to increase the value of your home or your investment property for the purposes of creating equity or a cash profit upon sale.  Can you, however, really make a profit with renovation?  And if so, how do you work out what is going to be profitable and what is going to be a whole lot of work for very little return?  Let’s take a closer look.

house and block.001Lots of people undertake improvements on their own home so that they can benefit from those improvements. Who doesn’t want a brand spanking new kitchen to enjoy? Who doesn’t want that lovely outdoor decked entertaining area? There’s absolutely nothing wrong with splashing out to your heart’s content on such improvements and forging ahead without calculating the financial feasibility and expected financial outcome of the improvements where your sole aim is to provide enjoyment to yourself and your family.  So long as you understand that that is exactly what you are doing.

This article, however, relates to those who are looking to do renovations that will result in financial gain, either through revaluing a property to access equity or selling a property for profit.  In this case, spending time on renovation feasibility is a must and can really save you a LOT of work in the long run.  Just because a house is run-down or can be improved, you see, does not necessarily mean that the project will stack up as a money making venture.  When you are renovating for profit you need to be adding value much greater than the funds than you are expending.

Just because you can doesn’t mean you should.

This is where many people come unstuck in their renovation project. You see it’s not about how beautiful the property looks at the end, as shows like ‘The Block’ may have you believe; it is all about the numbers. These are numbers that you can and must assess before you take on a project or buy a property.

These are the key numbers that are important in calculating your renovation feasibility:

  • Purchase Price — This is the price that you pay for the property.
  • Buying Costs — These are the costs associated with the actual purchase of the property and include things like loan establishment fees, mortgage broker fees, buyers agent fees, legal costs, stamp duty.
  • Renovation Costs — The cost of the actual work, both materials and labour to renovate the property.
  • Holding Costs — The costs associated with holding the property during the renovation and up to the sale (if you’re selling). This includes things like bank interest, council rates and charges, water, power, gas.
  • Selling Costs — These are the costs associated with selling the property and include legal fees, agent fees, advertising and any other costs associated with the property sale.
  • Profit Margin — This is how much money you want to make from the project.
  • Expected End Value or Sales Price — This is the expected value that the house will have or achieve at sale after the renovation has been completed.

In a moment we’ll walk through an example of a renovation feasibility and you will see that the differential between your purchase price and your end sales price needs to be quite significant in order to account for all of the costs in between.  This is where you will really start to see that turning a profit from renovating is not as easy as it sounds.

sample property

Let’s take our example property, which is a real deal that I looked at recently.  A great property in a fantastic location just crying out for renovation.  This is our ‘high level’ feasibility to determine if it’s worth looking more closely into the project.  If we can get our numbers to be someone in the ballpark of where we need then we’ll undertake more detailed analysis.

sample

So what you can see here is that if you buy the property at $440,000, spend 6 months or so renovating, ensuring that you spend only $30,000 on the renovation then you must be able to sell the property for $567,200 in order to achieve your aim of $40,000 profit.  Now that may not be easy.

Some key questions to ask:

  • Do renovated properties in this area achieve $567,200?
  • If so, can you renovate it up to this standard required for your allocated $30,000?

Once you lay out the numbers in front of you like this for any property you are looking at then you’ll be able to assess if the project really can make a profit for you and therefore you’ll become a lot more ‘choosy’ when it comes to selecting your property in the first place or deciding whether to renovate a property you already own for profit.

You can also use this exercise to run some ‘what if’ exercises:

  • What if I could buy the property for $30k less?
  • How does this affect my end sale value?
  • What if I could renovate for $20k instead of $30K?

You can run some scenarios and be clear about the maximum amount you can pay for a property to make your project work—and hopefully stick to that number and move on from the projects that look like they’d be great but just don’t stack up!

There are so many ‘renovators’ delights advertised but reality is that many of these are properties definitely in need of improvement but they won’t necessarily make you money.

Remember: Just because you can doesn’t mean you should!

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