Renovating your home? Find out how you can make a profit at the same time
RENOVATING or extending a house cannot only expand the living space of your family, but also renew it. And you can make a decent profit if you do it wisely.
ONE of the attractive features of residential property as an asset class is that owners can manufacture some capital growth: they can add value to a property, by extending it, renovating it, refurbishing it, or redeveloping it.
Renovating or extending a house cannot only expand the living space of your family, but also renew it — through added features such as a deck or extra bedrooms or a pool — to the point that it feels like a new home. A good renovation can give you better quality of life. And done right, it can add real and tangible value to the house.
There are only two only real limitations on this activity. The first is the danger of overcapitalising — spending more on the improvements than the value the renovation adds to your house, or the potential profit boost it could bring if you were to sell your property.
The second is how you fund the renovation.
This will depend on whether you embark on a ‘cosmetic’ renovation — for example, a fresh coat of paint, new carpet and lights — or a ‘structural’ renovation, where you’re knocking down walls and adding rooms, even levels. Some property experts consider that anything that requires spending less than 10% of the house’s value qualifies as ‘cosmetic’: another rule-of-thumb is that if you need a particular planning or building permit for the job, it’s structural.
Approaching a renovation, you have several choices for funding. If you have equity in your present home, you can simply extend your current mortgage — for which your lender will charge you a fee. The downside is that your loan repayments will increase and it will take you longer to pay off your mortgage.
You can redraw on your mortgage, provided your loan has a redraw facility and you have made extra payments on your mortgage: the total extra payments you have made can be used to finance your renovations. However, your loan balance will rise, and with it, your subsequent interest repayments.
Another alternative is to refinance your mortgage with a new lender — but this route may mean you pay exit fees from your existing mortgage, as well as upfront fees, such as application or establishment fees, on the new mortgage.
Some lenders offer ‘building conditions’ on loans, under which you can draw funds from the loan progressively as the invoices for building work come in. Your interest is calculated only on the progressive balance — that is, on the amounts you’ve drawn down to pay invoices. As you use your loan funds to pay more invoices, your interest charges will be calculated on the increased amount of funds used.
In some circumstances it can be possible to refinance your mortgage based on the property’s post-renovation value: some lenders will lend against the cost of the renovation if it’s done through a registered builder, with the plans and the building contract in place. This can reduce the amount of money that you have to stump up for the renovations.
However you fund the renovation, it is hugely important to fully understand all the costs you are likely to incur before you get started: both to avoid overcapitalising, and to make sure that your budget controls the renovation, and not the other way around. Be on top of your costs from the start.
These costs encompass not only the cost of the design and the materials and the work, but all of the preparation — for example, permits — and the on-costs, such as insurance and fees. You should pay for a valuation before you start, so that you have a clear starting point for keeping an eye on over-capitalisation.
Another potential cost is that you may need rental accommodation for a time, and to store furniture that needs to be removed from the work area. These are not incidental costs, they are critical to the project, and need to be factored into the budget from the very start — even in the lead-up to the decision. You will also need to consider the new furniture and fittings you will need to fill your new space.
Lastly, how the renovation affects your insurance is important to understand. Your home policy, which covers the dwelling and contents, may fall short of the cover required while building work is being done. Depending on your insurer and how its policy is worded, you could find that the cover on your home is limited while the renovation work is undertaken.
Before your renovation work gets under way, it’s a good idea to find out from your builder the precise details of your builder’s insurance as it affects you. Then, talk to your insurer about any changes you might need to make to your existing insurance to fit in with the new circumstances.
Major renovations will most likely increase your home insurance premium, to reflect the greater value of your home. It is always a good idea to inform your insurance company of what you’re doing to your home, because it would consider any damage claim on the prior value of the home. It’s your responsibility to inform your insurer of a renovation or extension to the house.