Four rules for maximising property renovation profits

As we look to what's ahead for 2012, Property Observer is republishing some of our most noteworthy stories of 2011.

The Block was a hugely popular TV show last year. Three gruelling months of sleeplessness and renovations paid off for three of last year’s four couples, who, on the face of it, seemed to sell their apartments for a profit.

Not surprisingly, it encouraged a new generation of property investors to turn their hands to renovation.

But if you ran the renovations of The Block as a business and added stamp duty, buying and selling costs, interest for the holding period and payments for labour, there was no commercial profit in doing these renovations. 

And it could be the same again this year.

Watercress, the production company behind The Block, bought four unrenovated homes for $3.6 million in November last year after they passed in at auction for $2.85 million. Once you add stamp duty and acquisition costs, this would have brought the cost of each house to about $950,000 before the renovations began.

With properties at the top end of Melbourne’s property market struggling to achieve prices anything like last year, the result of this year’s show will be very interesting.

Now don’t get me wrong ­– I think renos are a great strategy in our current flat property markets. They increase the value of your property, make it more appealing to tenants, increase the rents and manufacture depreciation allowances.

But my strategy is to buy, renovate, refinance and hold for the long term. It’s just too hard to make money out of a “buy, renovate and sell” strategy.

So where do you start? And how do you ensure you don't end up over-capitalising, as many investors do?

Here are four rules to follow to make the most of a "renovate-for-profit" property investment:

1) Determine the "right" purchase price.
Buying a renovator's delight at the right price is crucial in ensuring you are going to make some money when you finish your refurbishments. If you pay too much for your property at the outset, you will be chasing your tail trying to make the refurbishment profitable.

Start by determining what the end value of the property will be when you have completed all planned works. You can do this by researching the value of similarly renovated properties in your area.

Once you have the end value in mind, draw up an initial project budget to calculate your approximate renovation expenses. You should also consider getting a building and pest inspection on the property so you know exactly what you're getting yourself into, to help plan your budget accordingly.

Now, subtract all your costs from the end value, allow for a profit margin and this will give you a fair idea of how much you can afford to pay for your property in order to make your investment financially viable.

2) Be realistic with your budget
The truth is, the job will usually cost more than you expect, and take longer than you planned. With today's shortage of good labour, it's hard to get tradespeople to quote on renovation jobs. We've all heard stories of how the budget blew out and the project took weeks longer than expected.

It's never as easy as they make it look on TV. And, funnily enough, the tradespeople never look as good as they do on the shows, either – I am yet to encounter a tradesperson wearing neatly pressed overalls!

3) Consider the type of tenant you wish to attract
Think about the type of tenants you want to lease your property to and renovate with them in mind. Talk to your property manager to determine the predominant demographic seeking accommodation in the area, and plan your renovations accordingly.

4) Don't get personal!
Another mistake I see investors make is that they become too personal about the renovation project they are undertaking. Remember, you won’t be living in the place, so putting your own personality into the property is not necessarily a good idea.

If you keep things simple and the decor neutral, to simply make the property liveable and functional, you can't go wrong.

Property renovating is not a licence to print money. It's hard work, if you intend to do it yourself, but it's a great way to manufacture capital growth.

Michael Yardney is the director of Metropole Property Investment Strategists , a best-selling author and one of Australia's leading experts in wealth creation through property. He also writes the Property Investment Update  blog.