Key takeaways
Renovating is a smart investment strategy at this stage of the property cycle.
I don't suggest renovating to "flip", I prefer the BRRRR strategy of ‘Buy, Renovate, Rent Out, Refinance And Repeat
There are 8 steps to profitable renovations which I outline in this article as well as a renovation checklist
Have you considered getting involved in property renovations?
Making a tidy profit renovating a property seems like a very attractive proposition, doesn't it?
And that’s why more real estate investors are turning their aim to renovations.
You know… buying low, renovating cheaply and adding substantial value is the aim of the game.
It sounds simple enough, right?
Well, it's not really as simple as that.
Anyone can renovate, but that doesn’t mean they can make a profit, so let’s look at some tips to make your renovations more profitable.
Is renovating a smart strategy in today's property market?
The answer is yes!
Even more so now that we are at this stage of the property cycle.
Adding value through renovations is a great way to increase your rents and “manufacture capital growth.”
And that’s what I’m going to share with you in this Complete Guide to Renovating for Profit.
But let’s get one thing clear from the start…
Many people believe they’ll be able to renovate for a profit with a buy, reno, sell strategy, but as most property flips flop, I’m not an advocate of this technique.
I know seminars say sell and make a profit, but having been involved in renovations for almost 40 years I’ve learned that, unless you do major structural renovations or undertake property development, you won't make a big enough profit to sell on completion.
And that's definitely not for beginners.
Instead, I prefer the BRRRR strategy of ‘Buy, Renovate, Rent Out, Refinance And Repeat…
It’s just too hard to make a profit flipping properties that you've renovated, which involves losing big amounts of money by potentially paying Capital Gains Tax, plus stamp duty on the next property.
But if you renovate with the intention to retain the property, then you stand to retain all the benefits you’ve created in the renovation.
These include:
1. Low vacancies — As your newly-refurbished property is now attractive to a wider range of potential tenants, who are generally willing to pay a premium for better quality housing.
2. Higher rental returns — Receive higher rental as your newly improved asset shines against its competitors.
3. Depreciation benefits — Secondhand properties may attract fewer deprecation claims since the Federal Budget in 2017, but once you renovate you gain the tax benefit of extra depreciation allowances.
4. Manufactured Capital Growth — Using this strategy, you can essentially build your asset base, create capital growth and increase your overall wealth.
8-step profitable renovation strategy
With this in mind, here are 8 steps that I believe will help you on your way to a profitable renovation strategy
1. Why?
What’s the purpose of this project — in my mind it should be one (or all four) of the benefits I’ve mentioned above.
2. Preparation — finance & structures
Obtaining finance for your renovation project can be a little more of a dance than when buying a regular property.
You’ll need to borrow enough money to cover the property purchase and renovation costs and have some buffer for issues that crop up or any delays in the schedule.
Structuring your finances is a crucial task before the ‘real’ work can take place.
Are you using your existing cash flow to fund your renovation? Your equity?
3. Where?
Around eighty per cent of your property’s investment success will come from choosing the right location and the balance from buying the right property in that location.
And as you’re planning to keep your renovated property as a long-term investment, selecting the right location will be critical.
Research local markets to identify price points, what buyers want in a home or apartment, and all the usual factors such as supply and demand and times on the market, and most importantly a location with multiple long-term drivers underpinning its future capital growth.
In particular, I look for suburbs that are gentrifying — in other words where others are also renovating their properties
Once you’ve pinpointed a suburb with profit potential, target a property that fits the size of the renovation you want to undertake.
Don’t do it the other way around — find a property first and then try and then try and convince yourself this is where you should invest.
4. What? Buying the right property
Find a property with value-added potential but also one that has a functional floor plan and one that doesn’t require structural work.
Of course, if you’ve never picked up a hammer before but you’re keen to move forward with a renovation, it makes sense to start with a small project.
Be sure to acquire the research and knowledge that will allow you to mitigate your risk and give you the best chance of real success.
That means knowing how to protect yourself, how to choose the right property, and how to make sure it turns a profit for you in the end.
5. Purchase at “wholesale”
You need to acquire your property “at wholesale” (with built-in capital growth) so that you can renovate for pro
6. Budgeting and planning
There’s no hard and fast rule, but you should be fairly safe if your renovation budget doesn’t exceed 10% of the property’s value.
Be mindful of how long your renovation will take, as every day you delay costs you another 24 hours’ worth of interest on the mortgage, at a time when no rent is coming in.
And it’s important not to become emotionally involved and overcapitalise.
You see there is not a straight line between what you spend and how much value you add — some improvements (especially hidden ones like electrical and plumbing works) don’t add much value at all.
On the other hand, if you under capitalise, you won’t maximise your potential profit.
Don’t forget to leave a significant contingency (often up to 20% if you’re inexperienced) in your budgets because there always seem to be cost overruns and unexpected surprises in every renovation project.
It’s all about being prepared for the worst, so make sure you have sufficient funds available.
7. The Renovation
Now you finally start to get some of your hands dirty, but I don’t suggest you do the work yourself — instead, unless you've got the skills and the time, I recommend you act as project manager.
8. Lease, Refinance, go again
This is also the time to review your renovation against your initial budget and goals.
Learn and look for the best ways to profit from your development.
Renovation process checklist
This list includes many of the things you’ll need to consider during the renovation stage of your project:
1. Work out which tasks to outsource to others
- What jobs require you to be licensed — e.g. Plumbers and electricians
- Consider hiring a project manager if you’re not experienced
2. What requires Council Approval?
- What aspects may need this e.g. changes to the exterior (character areas)
- Internal structural changes
- Moving plumbing,
- Adding to the floor area or additional rooms
- A rubbish skip in the street
Council approvals will require documentation and architect’s drawings.
3. What needs Owner’s Corporation (Body Corporate) Approval?
- Talk to the owner's corporation manager and check their rules and limitations
- Permission to put an air conditioner on the balcony?
- Put a skip in the yard or car park?
- Structural changes, changes to exterior?
4. Source your trades
- Get a few quotes, especially for bigger jobs
- Set out a scope of work in writing, so everyone quotes the same information
- Have written specifications available on-site when trades arrive.
5. Purchase materials
- Following discussions with trades, you may find it is cheaper if they supply their own materials
- Open a trade account with your preferred supplier to access discounts
- Organise timely delivery. Materials need to be ready for your trades so as not to hold them up, but should not arrive too early and hang around, getting in the way or worse still getting stolen.
6. Determine the order of the trades and service providers
This will depend on the nature of your renovation project, and some trades will overlap (work simultaneously) but the workflow could look something like the following:-
- Architect, structural engineer — if structural work is needed
- Quantity surveyor for a scrapping schedule - a list of items that can be written off as immediate tax deductions when they’re scrapped.
- Builder
- Labourer — empty, demolish, and pull out old kitchen, and appliances.
- Plumber, electrician to disconnect services
- Cabinet maker — there is a time lag for the new cabinetry to be built
- Electrician, Plumber, Plasterer
- Painter
- The cabinet maker installed new cabinets
- Tiler
- Painter final touch-ups
- Carpet layer
- Landscaper
- Building surveyor to certify structural work
- Quantity surveyor for a new depreciation schedule.
7. Regular site visits
It will be your job to:
- Check that trades are in attendance
- The work is being done professionally and to.
- Troubleshoot
8. Site Clean up
Potential renovation mistakes
Renovating could make you a lot of money, but there are potential dangers for the unwary.
These include:
1. Rushing into a project with only marginal profit
It’s not easy to find a project that stacks up and delivers a good profit margin.
But don’t rush in…there’s no point in buying a property that’s only going to deliver a small profit margin or, even worse, lose your money.
2. Assuming that buying a cheap property will automatically make a good renovation profit
Cheap houses are usually that way for a reason.
And that’s often because of things you can’t change through renovations — it could be the location of the property a poor floor plan or the wrong type of property for the prevailing demographic.
There are always real estate bargains to be found, but make sure you’re buying a bargain and not a lemon.
3. Not understanding the area in which you want to renovate
Every suburb has streets that are more sought after and areas that are considered not so desirable.
Each location will have a price ceiling and adding more to your renovation costs may lead to overcapitalisation.
Understanding the subtleties of your target suburbs and the values of properties in the area will help you know when you’ve spotted a good renovation opportunity.
4. Overcapitalising
This is by far the most common trap for renovators when they spend more money than they could legitimately recoup in added value.
You can see how easy this is to do: you get excited by the renovation process, splurge a whole heap of money on fixtures and extras, and before you know it you have blown your budget.
I also see it a lot with second-tier properties where adding more expensive items doesn’t always add value.
5. Doing it cheaply
Occasionally I will walk through a home and ask myself, ‘What was the owner thinking?’
The fixtures are cheap, the cabinets are cheap, and the painting is shoddy and obviously a DIY job.
Prospective tenants or purchasers will notice these things, so even if you are happy to live with inferior paintwork or cheap fixtures, this does not mean others will.
You need to know to understand what level of ‘product’ is in demand in the area and deliver that.
You don’t need to install a commercial kitchen or the latest Bosh appliances to appeal to buyers, either, unless of course you have a generous budget in which case, the sky is the limit.
But if, like most people, you are on a budget, always try and ensure that you buy quality appliances.
They need not be the most expensive but try and avoid the cheap and nasty.
6. Not planning and costing your renovation before you start
You would be surprised by how many people, many of them extremely competent in their professional lives, don’t draw up a budget for their renovation.
This is of the utmost importance, especially if you are undertaking the project yourself.
Cost your labour and your materials first and then add them to the spreadsheet.
Also, factor in costs such as building delays and time spent away from work due to the renovations.
Make sure you add a buffer, too, for the unexpected.
If you are not an experienced renovator and you have a budget of $50,000, I would add $15,000 to that as a buffer because unforeseen things always come up.
7. Not factoring in the costs of buying and selling a property
Buying and selling property has significant costs attached and that’s why property flips (buy, renovate, and sell) don’t work.
Inexperienced renovators often find that all their planned profits have been eaten up in stamp duty, tax, and selling agents’ fees.
You need to allow roughly 5% of the property’s purchase price for buying costs.
When you sell, most agents charge a commission that is about 2% of the value of the property, as well as marketing costs.
And then you’ll pay tax on any profits.
That’s why I recommend my BRRRR strategy.
8. Not factoring in the value of your time
Managing a renovation project takes more time than you probably imagine and this has to be factored into your budget.
That's why, in general, I recommend you act as the project manager rather than as a tradesperson.
If you think you have loads of free time and spending your weekends and evenings renovating sounds like fun, then go knock yourself out.
DIY renovating means you need to live nearby.
You also need handyman skills or a keen attitude to learn
For the renovation to be profitable, it must earn you more dollars for your time than another part-time job would bring in.
It needs to earn you a lot more dollars in fact.
That’s because your part-time job doesn’t have a risk of failure like the reno does.
But beware…doing it yourself, is likely to end up taking longer and costing you more than allowing a builder to project manage your job.
Again, the aim of the renovation is to make you money, it's not for you to have fun (even though that's a good by-product), but if you looking to have fun or excitement go trail bike riding or bungee jumping.
Don't take the financial risk of a DIY renovation project.
TOP 5 reno budget killers
1. Not doing realistic feasibility and budget prior to purchase
It's interesting how this message keeps repeating itself.
If you’re a beginner avoid properties that require big reno and avoid properties that will require you to spend money on things such as fencing, stormwater, or rewiring as they can be costly, time-consuming, and don’t give you the visual ‘bang for your buck’ that you’re looking for.
Instead, look for properties that can be fixed quickly and cheaply.
2. Structural problems
These may require a lot of work and, are often hidden from sight, and therefore they don't add much perceived value at the end of your project.
One way of minimising this risk is to have a building and pest inspection conducted prior to purchasing your property.
Many older homes have foundation problems including rising dampness and repairing these could cost you an arm and a leg.
3. Extensive mold
Damage to the damp course on top of the foundations ongoing leaks or poor drainage can result in mold inside the walls.
This rising dampness causes mould on the walls and musty smells in the house.
Depending on the damage, this can often be expensive.
4. Electrical faults
Many old houses have problems with their electrical wiring systems.
If it’s necessary to rewire the house, the cost will likely eat into your profit.
But while it’s expensive, future tenants or prospective buyers expect the electricity to work as a standard, so the fact that the house is newly wired does little to impress them.
5. Termites
Termites can eat a house from the inside out.
Since they are usually eating structural parts of the house, the bill for removal and repair is usually in the thousands.
Again this is something you should look for in a building and pest inspection.
How to finance your renovation project
If you already have equity in your own property, you can take out an investment loan for the whole amount of funding, including the deposit, buying costs, and renovation, from your own equity plus the value of the new property.
Alternatively, if you already own the property you’re looking to renovate, you can take out the required funds for the renovation from the equity you may have in that property.
There are two ways to do this.
The first way is to cross-collateralise the two securities and take out one big loan to cover all funding.
The second is to use a line of credit.
1. Cross-collateralisation
This is when you use another property as collateral to borrow to buy and renovate a new property.
This means you have now tied up two properties together.
Many investors avoid this strategy because of a few downsides, including borrowing limits and the lack of flexibility down the line.
2. Line of credit
The second option is to use a line of credit against your home to cover a 20% deposit plus all purchase costs and renovation costs.
You then raise a stand-alone facility at 80% against the investment property.
The second is generally a better option if you’re looking to sell the property and move on to another renovation project.
The line of credit against your home will be retained for the next one, and going forward all you will need to do is raise 80% lends against the new purchase.
This avoids the cost of lenders' mortgage insurance, which can be significant and eat your profits.
Lending for renovations has become a little tougher of late.
If it’s a major renovation, most lenders will want a fixed-price contract from a licensed builder.
They will only lend on a completion valuation, so you will need to have all your costs done upfront.
If you already have equity in your home or another investment property, you could take out an investment loan for the whole cost of the renovation.
And if you're buying a property for renovation, you would normally fund this purchase using your equity in an existing property.
Alternatively, if you already own the property you are looking to renovate, you could take out the required funds for the renovation from the equity you may already have in the property — possibly through a line of credit.
You will need to have significant equity in the property or another property as lenders will not allow the overall funding to go above 80%.
ALSO READ: 10 steps to a high-profit renovation
