Jeremy Sheppard reveals his top 13 tips for how to make more money on your reno project.
1. Create a time plan for your renovation.
Factor in some big blowouts in terms of time estimates. Bad stuff happens; be prepared for it. If you’re hiring tradies to perform the work, you can save time by having some jobs completed in parallel. For example, you can have the outside painted while the kitchen is being installed.
Be sure to consider the logistics of each job, though. You don’t want tradies treading on each others’ toes. And you don’t want the carpet laid before the internal walls are painted.
2. Do your estimates conservatively.
Don’t be optimistic and don’t hope everything goes well. Assume something will go wrong; assume costs and time will blow out. Get crazy good at estimating everything accurately: purchase price, reno cost, sale price, etc.
3. Always invest in a location that has excellent growth potential.
Even if your reno is a failure, you’ll have capital growth to hold up the bottom line if you buy in an area that experiences growth.
4. Factor in a decent profit margin.
If you can’t find a project with high profit based on your estimates, then keep looking. Profit is the difference between the end sale price and the original purchase price minus all entry, exit, renovation and holding costs as well as tax.
Profit = End sale price – purchase price + purchase cost + exit cost + renovation cost + holding cost + tax.
Keep in mind that the capital gains tax discount is not available if your project is less than 12 months. Capital gains tax is not applicable at all if you don’t sell. But if you don’t sell, then future growth prospects are more important than the renovation.
5. Know the value of the end product.
Get familiar with the end product by visiting other examples of the product and seeing how much they sell for. The end product is properties that look similar to how you intend your property to look once renovated. Take photos of those properties, record their sale prices, and review these thoroughly.
6. Know the value of the start product.
Get familiar with the start product by visiting other examples of the product and seeing how much they sell for. The start product is properties that are cheap because they need a lot of work. Take photos, record sale prices, and review these details thoroughly.
7. Know the cost of the renovation.
Get familiar with cost estimates and timeframes for typical work such as a new kitchen, bathroom, floor coverings, internal/external paint, etc. That’s a short sentence, but a lot of work is involved in doing this. Don’t forget to factor in the cost of your own time.
8. Know the entry costs.
» Stamp duty
» Legal fees
» Lenders mortgage insurance if applicable
» Appropriate inspection reports
» Your time
9. Know the exit costs.
Exit costs consist of the selling agent’s commission, legal fees, and a bit of your time liaising with the agent and solicitor/conveyancer.
10. Know the holding costs.
Holding costs will consist mostly of interest payments on the mortgage but also possibly rates and insurance, depending on the duration and nature of the reno.
3 handy tricks to keep costs down
11. Keep your experts informed
1. Don’t be an impulse buyer. Stay true to your budget: if you plan to spend $100 on taps, keep it to that. The $250 special on a much better quality product might be appealing, but it’s out of your budget. Don’t even consider it.
2. Use tradesmen with a good local reputation. You might be tempted to head straight for the Yellow Pages or the internet, but you will probably get better results through your social network. Talk to anyone and everyone. Find out which builders the people you know have used and if they were happy with the work. You may start to notice that a few builders keep being mentioned.
3. There are loads of jobs you can do yourself. The easiest are painting and landscaping, but tasks such as tiling and paving are not beyond the DIY skills of most people. The trick is realising what you have time for. If you’re working a full-time job and only have time to do renovation work when you’re free, many jobs will be beyond your reach. It might actually cost you less to simply pay a professional rather than have a job drag out over weeks as you attempt to do it yourself.
Let your accountant know your plan before you buy. They can advise you on tax considerations and the best ownership structure for the project.
You might like to also let your mortgage broker know your plan before you buy. For example, if you plan to flip, they won’t advise a fixed interest rate or principal and interest payments.
12. Calculate the return on investment (ROI)
The ROI is the total profit after considering tax, divided by the total amount of money you put into the deal, calculated as a percentage. The money you put into the deal consists of:
» Entry costs
» Renovation costs
» Holding costs
The net profit is the sale price minus exit costs and tax. The ROI is the after-tax profit divided by the money you put into the deal as a percentage.
For example, a $400,000 property purchased with an 80% loanto- value ratio might have entry costs of $100,000 (don’t forget your own time). The renovation and holding costs might total $50,000 (don’t forget your own time). So the total investment is $150,000.
If the sale value is $525,000, then the gross gain before exit costs and tax would be $125,000 ($525k minus $400k).
Subtract from this the reno and holding costs and you have $75,000. However, the exit costs might be $12,000, leaving you with a net gain of $63,000.
Assume the property was flipped within 12 months, at a marginal tax rate of 30%, and you’re left with $44,100 in hand after tax. That means your ROI is 29.4% ($44,100 divided by $150,000 as a percentage).
If your marginal tax rate is 30 cents in the dollar, it’s unlikely a part-time job would earn you $44k over the project timeframe. And a 30% ROI is better than money in the bank. But is it the best investment you can do?
How to calculate ROI
13. Calculate what your time is worth
Purchase price: $400,000
Entry cost: $100,000 based on 20% deposit
Renovation + holding cost: $50,000
Total investment: $150,000
Sale price: $525,000
Exit cost: $12,000
Gross gain: $125,000 ($525,000 – $400,000)
Net gain: $63,000 ($125,000 – $50,000 – $12,000)
Assuming you sell within 12 months @ a marginal tax rate of 30%:
After-tax gain: $44,100
ROI: 29.4% ($44,100/$150,000 x 100)
Apart from the first few renos, you’re wasting your time being on site – except as a project manager. If you think you have loads of free time and spending your weekends and evenings renovating sounds like fun, then go knock yourself out. And once you’ve learnt your lesson, knock that attitude out of your head. To an investor, renovating is merely a means to an end.
DIY renovating means you need to live nearby. You also need handyman skills or a keen attitude to learn. If the renovation opportunity is not in an appropriate market, you may run into profit problems, even if the project itself went rather well.
For the renovation to be considered a success it must earn you more dollars for your time than a part-time job you could pick up. 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.
The whole idea of the reno is to force the issue of equity gain and force it with big numbers. If it’s not big numbers, you may as well work a part-time job for some extra cash, rather than put your effort into the reno.
Top 5 Reno Budget Killers
1. Electrical faults:
Many old houses have problems with their wiring systems. If it’s necessary to rewire the house, you’ll find the cost will eat into your profit line. Not only does rewiring have no visual aspect or wow factor, but it is expensive and 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.
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. If the house does not come with a clean termite bill, think again.
3. Structural problems:
Major cracks in the foundation of a house are usually signs of a serious problem. Old houses often have settling problems, but any changes that are less than 10 years old are usually the sign of an unstable house. Rebuilding the foundation will cost you an arm and a leg. The same can be said for fixing any structure that leans more than one degree.
Faulty drainage systems and rusty pipes can be a magnet for termites, not to mention that they can cause their own structural damage. Pipes can be ultra expensive to fix, and since buyers or tenants don’t see them, they are a renovation expense that, while necessary, have no value-adding benefits.
5. Extensive mould:
Untreated leaks or poor property drainage can result in mould inside the walls. Chances are, if you’re seeing black mould and the house smells musty, there is a major mould or toxic mould problem. There are a number of ways to cover the problem up, but if you’re aiming to renovate to hold, you’ll need to get rid of the problem for good, lest tenants complain. Depending on the damage, this can often be expensive.