Overcapitalisation can be a costly mistake for home owners. Many renovators assume that the improvements they make will improve the property’s value, but this is not always the case.
In this article we consider what overcapitalisation is and how it can be avoided. It comes from our free eBook, Renovation or Construction.
What is overcapitalisation in renovations?
Whether you are building a new home or renovating an old one, it’s advisable to keep it within the constraints of the ranges of homes within your community. You can put a million dollars’ worth of improvements into a home on a 500 m2 block in a blue collar outer suburb, but it will not come anywhere close to giving you a million dollars’ worth of resale value. That is due to overcapitalisation. Even though there may be ‘real value’ in the property, it’s priced outside of what the local market can bear. The market value is much lower than what you would consider the ‘real value’ to be.
How to avoid overcapitalisation
So, how do you avoid overcapitalisation? Begin by considering what price bands exist in your target community. A valuer referred by your lender can help you with this. If you are doing it on your own, you would start to identify what price bands are in place by looking for the obvious: a strip of waterfront properties, an area built on the side of a hill with exceptional views, areas affected by industrial use, train lines, etc. Where an area has a character unique as compared to the other areas around it, it’s likely to have its own unique price band. Now you need to work out a minimum and maximum for typical sale prices in that area. In doing this you cannot simply look at what the asking prices are. You need to consider historical values. Once you identify what the likely price band is for the area that you are looking at, recognise that it is going to be extremely difficult to sell a property in that area at a price over the top of the price band. No matter how much you spend on improvements, the market value is not likely to go much over the top of the price band.
Another approach to this is to seek to identify all of the features and characteristics that your home will have after the work is complete. Then look at recent sales of homes with those characteristics in the area where your home is – staying within the neighbourhood that has the same character. For each sale of a home that is anywhere close to having the same features and characteristics of yours, write down the price and whether that home is more or less valuable than yours will be. This should give you at least a ball park idea of what your home would be worth in today’s market after the renovations are done. Take that figure and subtract what you expect to pay for the renovations. If that figure is more than what you are likely to get should you put your house up for sale today, then the renovations are likely to be a good value proposition. If not, you need to consider how much money you are willing to lose in order to live in a house with those features for however long you are going to be there.
Funds for your renovations
It may be that you don’t have cash for your renovations. That’s not a big problem when you have a lender like State Custodians Mortgage Company to come to. Whether you need a full on construction loan or simply to refinance with a bit extra for more cosmetic renovations, State Custodians can help you. Give them a call today on 13 72 62.