House flipping may be on the rise, but make sure you think long and hard about the location, property type and value-adding activities before taking on a project.
You may not have to be a seasoned renovator to spruce up landscaping, freshen paintwork or replace flooring, but knowing how to locate a renovation gem and improve the overall value of a property for a particular area and demographic demands careful research, planning and budgeting.
If you’re pursuing a “renovate and flip” strategy, not only do you need to become an expert in the suburb that you’re intending to buy, but you also need to be smart about what you decide to renovate in order to generate the highest return possible.
Consulting the right professionals can help you plan and execute a renovation that will satisfy your strategy in adding value, appealing to a certain buyer and generating a healthy profit margin.
How to renovate for profit
1. Assess risks
Like any investment strategy, there are some risks that come with the “renovate and flip” strategy. The greatest risk is that you may be unable to sell the property for a profit or you may not be able to sell for the profit margin that you set out to achieve. This may be a result of purchasing the wrong property type, purchasing in the wrong location or not planning efficiently.
To manage these risks, you need to be realistic not only about your budget and profit margin but also about the time and planning of your renovation project. You should enlist the services of professionals such as a contractor, an accountant, a financial planner, a home appraiser, a mortgage broker and a local real estate agent to ensure that you don’t blow out your budget or make the wrong purchasing or finance decision.
When inspecting the property, it’s a good idea to get a building and pest inspection to identify any structural problems, as this may offer you greater negotiating leverage if you decide to proceed with the purchase.
2. Define strategy
You need to consider whether you are planning to buy, renovate and sell or whether you want to buy, renovate and hold. If you’re planning to sell, you want to ensure that a quick profit margin will be guaranteed. If you’re planning to hold the property for a period of time, then you want to ensure that it will benefit from capital growth.
Again, recruiting a team of trusted professionals can help you refine your strategy from the outset.
Know where to add value
Kitchens and bathrooms are important to homebuyers because of their aesthetic appeal and because they are high-traffic areas. For a cosmetic renovation, focus on upgrading areas that are visible. For instance, you may want to change the light fittings or add a splashback to the kitchen sink.
A local home appraiser and real estate agent can help you decide which areas are worth upgrading and the likely return that they will yield.
3. Market research
Become familiar with the property price and market conditions of at least three neighboring suburbs of interest.
Research renovated properties similar to the one you’re thinking of buying so you can estimate a realistic sale price for your property. Look at the historical capital growth rates for the market as well as demand and supply factors and the demographic of residents in the area.
You can use sources such as Niche and Neighborhood Scout to generate suburb profile reports.
4. Property selection
Once you’ve selected the suburb for your property, you need to decide which type of property is likely to outperform the market. Speak to a local real estate agent or consider hiring a buyer’s agent to help you better understand the type of property — whether it’s an apartment, condo or house — that will allow you to renovate without overcapitalizing.
Inspect several properties and keep an eye out for any structural problems. Check the electrical and plumbing and look around the windows for rotten boards, as these can be expensive to repair.
Ideally, you should find a property for 20% below the median price for the suburb that is cosmetically distressed (such as poor paintwork or outdated interiors), as this will ensure that it has good renovation potential. You may also want to consider a discounted property such as a deceased estate or a foreclosure auction, which can present strong buying opportunities as the vendor is often looking for a quick sale.
If you need help finding and buying a property to renovate, you can also enlist the services of a professional buyer’s agent.
Professional renovators recommend that you spend no more than 10% of your property value on the entire renovation. For example, if you buy the property for $550,000, then you shouldn’t spend more than $55,000 on the renovation. Make sure your budget accounts for the deposit, stamp duty, renovation project costs, mortgage repayments as well as a contingency buffer.
Your profit margin should be roughly 10% to 15%. You can estimate your profit margin by forecasting your final sales price and then subtracting the original purchase price and renovation and holding costs. Depending on the location and property type, cosmetic upgrades can generate $15,000 to $75,000 in seven to 10 weeks.
Keep in mind that property appraisers can help you allocate your budget across different areas. For instance, a local appraiser may know that if you spend $15,000 upgrading the cabinetry of a property, then this may add around $25,000 in equity.
A quantity surveyor can also help you understand what you should be paying for labor and materials to ensure that you’re not overcharged. They can also provide you with a depreciation schedule to highlight the deductions you can claim in your tax return.
When comparing quotes, you need to ensure that you’re comparing apples with apples. For instance, if you get three quotes for a tiling job, you want to ensure that all three quotes provide an estimate price for the same scope of work such as waterproofing, materials and labor costs. This makes it easy to compare suppliers when choosing the one that offers the best value for your money.
To help you stick to your renovation budget, you should negotiate with tradespeople to see if you can get a better price. Try to find a one-stop supplier for all your materials so you can negotiate bulk discounts.
6. Organize finance
Strike up a conversation with a lender or a mortgage broker who can give you access to a panel of lenders and negotiate for a competitive deal on your behalf. A mortgage broker can help you understand your borrowing power and compare different home loan products.
7. Timeframe and planning
From area measurement to concept agreement and execution, finalizing your renovation project timeline is critical to ensuring project success.
During this stage, you need to determine the scope of the work and break down your timeline and budget into itemized projects. You’ll also need to decide whether you’ll manage the renovation yourself or whether you’ll hire a project manager (for major structural renovations).
You’ll need to factor in the time taken for any administrative requirements for the renovation, such as seeking city approval.
What are some easy projects that can generate profit?
- Painting. A quick paint job can make a property feel fresh, spacious and modern. This is a low-cost and quick way to add value to a property.
- Curb appeal. This is another way to enhance the value and sellability of a property. Enhancing your curb appeal may include activities such as basic landscaping, installing a modern letterbox or paving the walkway to the front door.
- Door handles. If you don’t want to replace the cabinetry within the property, you can simply replace the door handles of the doors and cupboards, which can give it a more modern feel.
- Lighting. Replacing the light fittings is another simple and affordable way to change the aesthetics of a room.
- Window furnishings. Replacing window furnishings can make a space feel more contemporary and open.
Tips for renovating for profit
- Do your research. Undertaking extensive suburb and property research is critical to a successful “buy and flip” strategy. The location, the property and the type of renovation are all important factors that determine your ability to generate a profit.
- Be realistic. During the planning stage, you need to be realistic about your renovation timeline and budget. You also need to be realistic when estimating your profit margin as this could make or break your profitability.
- Consult professionals. Build a team of licensed and trusted professionals who can help you follow your project plan and budget.
- Buy below market value. You should generally purchase a property that is 20% below the median market value if you want to renovate for profit.
- Cosmetic upgrades. Avoid major structural upgrades and focus on cosmetic and visible upgrades.
Common mistakes when renovating for profit
- Paying too much. The amount you spend on your property will largely determine the profit that you make from the property. To avoid overpaying for the property, try not to make decisions based on emotion. Recruit a team of professionals to assist you with the buying process.
- Overcapitalization. Blowing out your renovation budget can create cash-flow problems down the track. To avoid overcapitalizing, use a professional valuer to help you fully understand the kind of activities that will add value to your property. You may also want to hire a surveyor to help you understand any tax or depreciation items that you can claim. Another way to avoid overcapitalizing is to have a buffer of funds in place — normally 20% of your overall budget — for any contingencies that may arise.
- DIY projects. Don’t cut corners with DIY projects. While it may seem efficient and cost-effective at first, if you don’t complete the work correctly, you may end up having to pay more in the future to repair the job.
- Ignoring future buyer. Consider what will appeal to your target audience. Pursuing neutral designs and enhancing your curb appeal are some ways that you maximize the sellability factor of your property.
Apply for Financing
What are the tax implications of renovating for profit?
If you’re renovating one or more properties, you need to decide if you are a personal property investor, undertaking profit-making activities from the renovation or carrying out a business of renovating properties.
For more information about the treatment of tax when renovating for profit, visit the IRS website.