‘Overcapitalising’. Even those who don’t know what it is can probably tell by the name that it’s nasty. Here we explain what it is, why it’s bad, and how to avoid it.
Property Overcapitalisation
The concept of overcapitalisation is simple to grasp. A property owner overcapitalises when they make modifications, changes, and enhancements to a property that cost more than the additional value they add to it.
Each property has a ‘ceiling’ value. Depending on where the property is located and the health of the real estate market, it may be difficult to sell for more than a specific price. For example, in a neighbourhood where a regular 3-bedroom free-standing house sells for $800,000 and a modern, elegant home sells for $1 million, spending $500,000 to upgrade an average property makes little financial sense. Based on market conditions, the property is unlikely to ever outperform other neighbouring properties.
People’s money spent on improvements does not necessarily increase the value of their home. Understanding this equilibrium helps to avoid overcapitalisation.
Why is Overcapitalisation Bad?
Being the prettiest and most costly house in an area may be OK – someone has to own such a place – but being much over the market rate just means you’ll struggle to get a return on your investment, especially if you need to sell in the years following an update.
So while people naturally gravitate to more affordable western suburbs such as Tregear, Mount Victoria and Bidwill to get a toe-hold on a home, creating a luxurious, sprawling 3-storey palace with marble floors in these suburbs probably won’t see much return on your investment.
Of course, if money and investment value are not your primary concerns and you truly desire a rooftop garden and pool on top of your 1972 brick veneer house, go for it. Some people will benefit from it even if it is not a wise financial decision. If you’re living in a property for the foreseeable future, it might as well be comfortable and reasonably up to date.
For the majority of us, however, the value of our home is a critical component of our financial planning and future goals. If you fall into this category, you should ensure that any property upgrades or renovations increase – or at least preserve – the value of your property.
Ways to Avoid Overcapitalisation
Doing nothing to your property is one sure-fire way to avoid the overinvestment trap. However, over time, things become outdated. People who sell outdated, unrenovated properties might easily be accused of undercapitalising. A $25,000 kitchen renovation will generally result in a final sale price that exceeds the $25k investment.
Adding Value the Good Way
If you’re looking for methods to add value to a property you want to stay in, consider your own comfort and the rooms that date the fastest. Kitchens and bathrooms are excellent places to start, where little improvements can make a significant difference to your comfort and quality of life.
If you’re renovating a property with the idea of selling soon, even small cosmetic adjustments can make a tremendous difference:
- New interior and exterior paint
- New light fixtures
- Updated curtains and shades.
If your house is showing signs of age, some major renovations can have a favourable impact on your final sale price:
- Modernised kitchen and bathroom
- New carpets and polished floors
- Landscaping.
To avoid overcapitalisation, consider where your property value falls within your locality and what changes similar properties have recently seen. If you’re selling, put your personal preferences aside to some extent and concentrate on what draws people to your location.
The 10 Percent Rule
There isn’t much science behind it, but some property experts advise owners not to spend more than 10% of the value of their house on improvements. In a competitive real estate market, it pays to explore ways to maximise your effect while spending a little less.
Remember that if you’ve been in a house for a while, you probably have equity, which allows you to borrow against the value of your property. And even without equity, there are other ways to fund a renovation if you really need to spruce the place up.
Contact us.
At Mortgage Broker Sydney, we can provide market insights on previous property sales in your area, which is an excellent approach to determine how much to spend on a refurbishment. We can also assist with applications and financing, taking the hassle out of dealing with a bunch of banks.
Michael began his career in the finance industry over 35 years ago. He progressed through the ranks at the CBA in both retail and corporate lending, culminating in a senior position as a Corporate Relationship Executive. His decision to leave the bank in 2003 to become an independent mortgage broker was driven by his desire to assist everyday customers break through the jargon of the banking world and access the best loan products in the market. His experience is wide-ranging from helping first time buyers to large commercial enterprises. What Michael doesn’t know about home loans, simply isn’t worth knowing!