‘Overcapitalising’. Even people who don’t know what it is can tell by the name that it’s a bad thing. Here we explain what it is, why it’s not great, and what you can do to avoid it.
The idea of overcapitalising is easy to understand. A property owner overcapitalises when they undertake upgrades, updates and improvements to a property that cost more than the extra value they add to that property.
Every property has a ‘ceiling’ value. Depending on where the property is located and the state of the real estate market, there’s a certain price point it would struggle to exceed in a sale. For example, in a location where a typical 3-bedroom free-standing house sells for $800,000 and a modern, fancy place might sell for $1 million, it wouldn’t make financial sense to spend $500,000 upgrading an average property. Based on the market, the property is unlikely to ever be so far ahead of other places nearby.
The money people spend on renovations doesn’t automatically make their place worth that much more. Understanding this balance helps avoid overcapitalisation.
Why is overcapitalisation bad?
Being the nicest and most expensive property in an area might be ok – somebody has to own such a place – but being way over the market rate simply means you’ll struggle to get a return on your investment, especially if you need to sell in the years immediately following an upgrade.
Of course, if money and investment value is not your main focus – and you really want a rooftop garden and pool on top of your 1970s brick veneer house – go for it. It doesn’t have to be a good financial decision for it to suit some people.
For most of us, though, the value of our home is a central plank in our finances and our plans for the future. If you fall into this camp, you’ll want to be careful that any property upgrade or renovation will add to – or at least maintain – the value of your property.
Ways to avoid overcapitalisation
You could always just do nothing. Over the years, though, things get old and out of date. People who sell old-fashioned, unrenovated places can easily be accused of actually undercapitalising. A $25,000 kitchen renovation will often add more than that amount to a final sale price.
If you’re looking for ways to add value to a place you intend to stay in, look at your own comfort and the rooms that date the fastest: kitchens and bathrooms are a great place to start, with moderate renovations often making a big difference.
If you’re doing a property up with the intention to sell soon, some simple cosmetic changes can make a huge difference:
- New interior and exterior paint
- New light fittings
- Updated curtains and blinds.
If your property is showing signs of age, some bigger changes can also have a positive impact on your final sale price:
- Modernised kitchen and bathroom
- New carpets, polished flooring, etc.
To avoid overcapitalising, understand where your property value sits within your location, and look at what changes similar properties have made recently. If you’re selling, put your own preferences aside to an extent, and focus on what attracts people to your area.
The 10% rule
There’s not much science to it, but some property experts advise owners not to spend more than 10% of the value of a property on renovations. In a tight property market, it pays to look for ways to maximise your impact while spending a little bit less.
At Mortgage Broker Melbourne, we can give you market insights regarding recent property sales in your area; a great way to work out how much to spend on a renovation. We can also help with financing, taking the headache out of bank negotiations.
Talk to us today.