Deciding when to renovate your investment property is something you should base on cold, hard facts. Here's how to know whether now is the right time.
When renovating your home, your personal situation and preferences will typically be the drivers for your decisions. In contrast, renovating your investment property needs to be considered as a business decision. The extent and timing of your renovation will depend on a host of factors, and your own tastes should be the last thing to influence when and what you spend your money on.
The target tenant
Your tenant is your customer. When you’re considering updating your property, you need to determine what your likely target demographic will be and what elements of a home they prioritise. If your property is in a colder regional town, your tenants will likely prefer ducted heating and carpet; compared to an inner city tenant, who might place more value on a dishwasher and a renovated bathroom. Determining your tenant’s wishlist means you can focus on spending money on the right things and not ‘overcapitalise’ in the short term. If your investment strategy is to hold on to the property for the long term, consideration also needs to be given to wear and tear of your renovation. While your hip pocket might benefit from some tax write-downs, this depreciation payment is because the taxman is acknowledging that your new appliances, bench tops and carpet are in fact declining in value.
Source of funds
Funds for renovations will either be sourced from equity (borrowings) or savings.
If the renovation costs are coming directly out of your savings account, then you need to consider what your opportunity cost is. What are your alternative investment options for that money? Is this the best use for your funds? In some cases, spending your current savings on a renovation might delay your ability to purchase your next investment property if you’re planning on increasing your portfolio. If you can sustain a lower rental return for the medium term and then harvest your equity to conduct the renovations a few years down the track (depending on your capital growth), your opportunity cost will be minimised.
If you’re able to access borrowed funds, such as a line of credit, it will be far easier to do a cost-benefit analysis. For example, if you were able to borrow $20,000 at an interest rate of 5%, an interest-only loan would calculate your repayments to roughly $20 per week. If your $20,000 renovation can increase your rental return by a minimum of $20 per week, then you’re at an advantage with the added bonus of also increasing the value of your property.
If your objective for renovating is to increase the value of the property (to refinance, enhance your LVR or potentially sell), you’ll need to spend some time researching recent sale prices in the area. Your property might be ripe for renovation if you've bought under ‘market value’ or if the area has had a recent glut of higher sales results. In some markets you may find that when an un-renovated property is $X and your renovation will cost $Y, then often $X + $Y equals the price that renovated properties are selling for, removing your margins for profit. If you have the skills to renovate yourself, then you’re in a stronger position; but if you’re outsourcing you also need to factor in vacancy, delays and cost blowouts. If renovating yourself, you cannot neglect the cost of your time (and the money you could have been earning had you not been renovating).
Your motivation might be to improve your rental yield, and depending on your source of funds you need to determine if the weekly rental will increase enough to justify the capital outlay. One outcome that investors can overlook is that even if their yield hasn't increased, their chances of improving the desirability of their property (and hence a reduction in vacancy) is still an advantage. The quality of tenants and the longevity of the tenants are often significantly enriched when a renovation is done suitably.
Renovations or ‘capital improvements’ are defined by the ATO as improving the condition or value of an item/structure beyond its original state at the time of purchase. Investors can claim these improvements as either a capital works deduction or a depreciation deduction over a period of time. This is classified differently by the ATO than repairs and maintenance, which can be entirely claimed for that financial year. A discussion with your accountant is recommended to clarify your potential tax benefits of your upgrade and what category they might fall into.
Understanding what the target tenant wants
The most crucial element to consider when planning an investment property renovation is the target tenant’s wishlist. As areas gentrify or increase in value, the target tenant can change. Their lifestyles can alter and the items in a home that they gravitate to can also alter over time. Understanding what aspects of a home a target tenant will value can make the difference between a short tenure and a long-term tenure. A renovation doesn't need to necessarily be a styled conversion or an expensive design. A well-timed, well-executed and sensible renovation should always take into account what a tenant will pay and stay for.
Amy Mylius is a Buyer's Advocate with Cate Bakos Property in Melbourne. She has a Commerce/Arts Degree and a Certificate IV in Property Services. Amy has come from a background in property leasing and previously owned her own business in the energy efficiency field. Amy has strong research and analysis skills, which she applies to all facets of property investing, including historical sales analysis, rental appraising, cashflow projection and suburb gentrification.