To prevent your renovation from becoming a ‘never again’ experience, here’s what you need to know before you get started. By Eynas Brodie.
You’ve found an undervalued property that screams potential and is a great opportunity to renovate for profit. Congratulations! You’re off to a cracking start. But before you roll up your sleeves and start looking at colour charts, there are a few things you need to know to protect your finances, your profit margin and above all, your sanity. For couples undertaking a renovation together, there’s also the important matter of a relationship to preserve!
According to Ana Stankovic of Winning Formulas for Success, a lot of investors walk blindly into projects not knowing what’s going to be involved, how much it’s going to cost, the length of time it will take, what will add value and give the highest returns, what order things need to be done in and how profitable even the worst-case scenario is going to be.
“Property investors Australia-wide are recognising that the basics of buying and selling aren’t enough in today's market and are turning to add-value strategies,” she explains. “(But) mistakes in failing to identify and accurately calculate the profitability in deals are increasing investors’ risks and costing them the opportunity to recoup lucrative profits.”
So what are the main pitfalls to avoid?
1. Underestimating the cost
“A frequent mistake made by many investors is not to cost out their renovation accurately upfront,” Stankovic says. “They should know the detailed costs of a renovation before they even make an offer. Instead of having a ballpark figure, for example (saying) ‘we’d like to spend $40,000 on the renovation’, they should break it right down to how many power points they want to add, doors to replace, etc.
“The more detailed the information is about what you want to do with a project, the more accurate your costing projections will be.”
Stankovic relies on a checklist when she inspects a property to capture even the smallest detail of what needs to be changed, added, removed or repaired.
“Having this level of information about the property makes it much easier to get and compare tradesman quotes… as well as to get discounts on materials by giving them a full list of what’s required,” she explains.
Renovate for Profit director Cherie Barber agrees that not doing a detailed financial feasibility beforehand is the downfall of many investors.
“They make a wild guesstimate or assumption that they’re going to spend X amount, only to find that they run almost double of their original estimate at the end of the project,” she says. “It’s a lack of detailed number crunching that causes a lot of renovators to make no profit or a loss at the end of their reno projects.”
She suggests sourcing as many quotes as possible before you buy so you can firm up unknown costs in your financial feasibility.
2. Not doing a profitability analysis (financial feasibility)
Once you’ve worked out how much the renovation will cost you, the next step is to calculate how much profit it will make you.
Stankovic says many investors struggle to analyse a deal and calculate profitability before purchasing a property, so they either miss out on an opportunity or walk away with little or negative returns.
“When analysing to see if a project is going to be profitable, they need to take into account all project costs including purchasing, holding, adding value, selling, loans, and also take into account the resale that can be achieved following the renovations,” she says.
“Performing profitability analysis is key to knowing just how much profit there is in a potential deal. This not only helps investors compare different deals but it also makes it easier to analyse different variations within the same deal.”
Stankovic says regardless of whether you intend to renovate and sell; renovate, subdivide and sell; knock down and develop; or renovate and develop in the backyard, “it all comes down to being able to calculate the profitability of each option and look at a profit figure based on how long it takes to do that strategy”.
“A big renovation might not yield as much profit, but it averages at only three months of effort before it’s put back on the market, instead of 18 months’ average with a development,” she points out.
“The profit figure for a project should be broken down into a per month profit figure to truly see which strategy is best for that property.
“You might find that the renovation will yield a better per-month return than a subdivision or a development, purely because it can be completed so much quicker, sold, and the investor can then concentrate on repeating the process with their next deal. This means that you can complete a lot more deals within 12 months.
“Being able to precisely crunch numbers on a property investing deal and instantly reveal profit in cash (if selling) and cash flow (if holding) is critical to making informed, strategic decisions and being successful in the property investing game,” says Stankovic.
3. Getting the suburb selection wrong
Barber encourages renovators to stick to one suburb they know well or three suburbs maximum.
“Many renovators lack focus or specialisation in three suburbs or less,” she says. “They dart from suburb to suburb looking for reno opportunities anywhere and everywhere and therefore don’t acquire intimate knowledge on the supply and demand factor in suburbs.
“It’s important for renovators to become a master of one, not a jack of all trades when doing their suburb due diligence.”
4. Not researching the property
“Many renovators don’t fully research the property they’re buying,” reveals Barber. “They fail to assess basic merits of a property like positive and negative buyer objections and how this will affect the resale of their renovated property.”
She suggests using a checklist, which will force you to research everything before you make the purchase.
“It’s very easy to get into a property but very hard to get out.”
5. Making a rash offer
If you see a property on the market that’s ripe for renovation, make sure you factor the renovation costs when you’re negotiating your price.
“The purchase price should be a reflection of the analysis performed (see Mistake #2) and have the renovation costing and profitability analysis information to back it up,” says Stankovic.
“Don't be afraid of including a screenshot or a printout of the research that you’ve done to show the agent how that figure you’re offering was derived. The more information that they have about the basis of your offer, the easier it will be for them because they’ll be able to go back to the vendor with supporting information and you stand a better chance of getting your offer accepted.
“In the same way, if you’ve done your analysis and have calculated that even your worst-case scenario profitability is going to be above a certain figure, for example $50,000 in clear profit or more, then don't procrastinate and for the sake of a few dollars miss out on a whole deal.
“We’ve sometimes offered more than what they were asking for in order to secure a deal that was going to make us more than $120,000 in clear profit in less than six months. Sometimes people look for the perfect deal and instead don't end up doing anything at all in that time.”
6. Failing to plan
Not having a clear plan of what your renovation will involve can lead to cost overruns and the outcome may not meet your original objective, warns Angus Kell of Archicentre.
“This can be solved simply by ensuring you have a proper and appropriate plan which should include either a written scope of works (a specification) or, for more complex works, a set of drawings providing a visual representation of the works required,” he says.
If you’re outsourcing the renovation to professionals, this may mean paying an architect or draftsman to draw some designs. If you intend to coordinate the reno yourself and use different tradies for different aspects of the project, then it helps to show them magazine clippings and photos of the look you’re trying to achieve.
When using tradies for some or all of your project, make sure you have a written agreement in place that spells out exactly what your expectations are, Kell adds.
“Proceeding without having an adequate written agreement on the scope and quality required leaves both the scope and quality open for interpretation by the tradesperson who may have a very different idea than the investor,” he says.
7. Using dodgy tradespeople
Kell says another trap DIY renovators fall into is using contractors who don’t have the skills to complete the work to the standard required.
“It’s important when undertaking any renovation that licensed and suitably experienced tradies are engaged, and appropriate pre-qualification should be completed prior to engaging the tradies,” he says.
8. Confusing fiction with reality
Aussies love renovation TV shows, especially ones that show a whole house being magically transformed in a single weekend.
“The reality is this is not real life renovating,” states Barber. “It’s called entertaining TV!
“Many people think renovating is about donning your funky bandanas and ripped jeans and getting messy with the paint cans. Enter reality, a property cannot be magically transformed in a weekend, it’s more likely to be a matter of four weeks at a minimum and everything doesn’t magically go to plan as well as the TV shows depict.
“Renovators should be aware of the realities of how long their projects will take, what effort will be required and the costs involved to complete the project. They never show this on the TV renovating shows.”
So instead of watching renovation shows to see how it’s done, Barber suggests you “get off your couch, turn off your TV and get yourself onto a real renovation site to see what it’s really like”.
9. Doing the wrong type of renovation
The reason many renovators overcapitalise isn’t just because they spend too much money on their improvements, it’s more to do with the types of renovations they choose to do, according to Stankovic.
“This shouldn’t be a judgement call, but rather based on what’s going to achieve the best returns,” she says.
“It’s really important for investors to be selective about which renovations they’re going to perform and only do the ones and use the materials that will add the most value.
“To give you an example, French doors cost about half of the cost of putting in bi-fold doors, however they add just as much in value with most properties.
“What renovations you choose to do will depend greatly on the type of property, where it’s located and who your target market will be for resale. There’s no point putting in high gloss tiles into a family home where they’ll likely have kids and pets and be safety concerned, no matter how good they look.”
Cherie Barber adds, “Most people don’t know all the ways in which you can add value to a property through renovation. It’s the renovator’s job to find the best and most appropriate use of the site at a profitable outcome. Most people don’t have the knowledge to undergo this process, or have such tunnel vision when assessing renovation deals that they can’t find creative options for the property to maximise its true potential.”
She suggests investors educate themselves and learn from other successful renovation projects.
10. Renovating to your personal tastes and ignoring your target market
If you don’t know the demographics of the suburb you’re renovating in – who the buyers or tenants are and what they want in a property – you may create something nobody else wants.
“Renovators should always know who the buyer of the renovated property will be before they buy the property themselves,” stipulates Barber.
“Many renovators make the mistake of renovating a property based on their personal likes, not the likes and needs of the demographics buying your renovated property.
“Become an expert in your suburb due diligence,” she advises.
11. Lacking time management and organisational skills
Barber has seen countless renovators approach their renovation projects in an ad hoc, almost chaotic fashion.
“They lack professional (skills) and a structured discipline onsite, rarely work to a system and as a result don’t manage their projects in an effective and efficient manner,” she observes. “A lack of a structured system will cause time and cost blowouts.”
She says a standard six-week cosmetic reno typically takes five months from start to finish, while a standard six-month structural renovation takes almost a year from start to finish. For investors who intend to flip the property (renovate and sell), this includes the purchase settlement period, the renovation process, marketing the property for sale and the selling settlement period. For investors who intend to renovate and rent, it includes the purchase settlement period, renovation process and the time taken to find a tenant.
The problem is that most people factor in mortgage holding costs for the renovation time only and don’t factor in the other time elements of the deal, Barber says.
“Mortgage costs are a significant project expense and, if not factored correctly into your feasibility, can lead to a cost blowout and a reduction in profit for many renovators. All too often you see someone buy an unrenovated property, start the reno and then not have enough funds to complete the project. This is because they didn’t factor in when cash would be coming in and out over the period of the project.”
12. Paying too much for materials and labour
If time is against you, you’re likely to spend more than you have to on your renovation, warns Barber.
“When a renovator lacks time, it’s likely they won’t have time to negotiate on their goods and trade labour and therefore end up paying too much for their goods and materials which diminishes the financial viability of the project,” she states.
The way around this is to learn to project manage your sites like the experts do. “Microsoft Project is great for this.”
13. Not knowing when the resale will be
Timing can play a big part in how much money you’ll sell your renovated property for, believes Barber.
“Most people don’t consider the time of year they take their renovated properties to the market for sale,” she says.
“Certain seasons can mean a huge price difference which results in reduced profitability. Many people sell their completed reno projects immediately on completion and hope for a buyer to come along. They give no thought to the time of year and the demand/supply considerations in that season.”
Barber suggests renovators become informed about stock levels and subsequent price levels during each season.
14. Paying too much tax
Barber has met many renovators who don’t set up proper structures for their renovation investment, which she says results in “copious amounts of capitals gains tax, especially when selling their renovated projects on completion within 12 months of owning them”.
She encourages renovators to invest in a good property accountant in order to determine the best financial structure to use for their property venture.
15. Lack of education
Investing in property renovations can be a gamble for those who don’t have enough knowledge on the subject, says Barber.
“What isn’t taught at schools therefore needs to be learnt elsewhere. This therefore requires all of us to invest in our own self-education, either by reading books, magazines, attending seminars or learning from people who are successful in that field. If people did this, many mistakes and costly errors would be eliminated while undergoing their renovation projects.”