How To Identify A Gem
It’s crucial to look beyond what is there and envision the potential, writes Nick Gentle.
31 August 2019
Property finders are always looking for properties that can be improved. One advantage real estate offers over many other forms of investment is that you can materially improve the value of your asset, which makes locating assets that can be improved quite a useful skill.
Renovating or developing a property to increase the value or rental yield is known as creating equity or cashflow. Here is a simple example:
- You buy a property for $500,000 that has a rental appraisal of $500 per week.
- You spend $40,000 on a complete cosmetic renovation, after which the property is valued at $600,000 and has a rental appraisal of $600 per week.
- The $60,000 increase in value from your total spend is your created equity.
- The original gross rental yield was $500 * 52 weeks / $500,000 = 5.2%
- The new gross rental yield is $600 * 52 weeks / $540,000 = 5.8%.
The result is you not only have created equity through your good work, the cashflow from the property has improved also.
There are many different ways to add value or develop a property that will add value and/or cashflow. Here are a few examples:
- Cosmetic renovation
- Improve outdoor spaces and off-street carparking.
- Furnish the property.
- Add an extra dwelling to the site.
- Subdivide and develop (or sell) the created site.
- Add bedrooms by remodeling or extending.
- Separate an existing house into multiple dwellings.
- Change the use of the property.
I have successfully added bedrooms and cosmetically renovated, which means I both increased the quantity of income streams and the quality of the asset. To add bedrooms I have remodeled properties and I have also extended them. On one adventurous project we did both.
Some of the above types of value-add projects can be undertaken without any form of consent and some will require a building consent and a resource consent. The consenting process is expensive, especially when you factor in design costs and it can be very slow. I mentally set aside a month for working drawings and one to two months for the council approval process. As a result, I have a personal policy to only go through the consenting process for projects that will be highly profitable.
How To Identify Properties With Value-Add Potential
The most important thing to keep in mind is that properties and target tenants are different in every market. What I look for in Wellington is very different from what would catch my eye in Rotorua and the below list will not all apply to every market. Think about who will live in the property afterwards and make sure the numbers stack up.
Here are some things you can look for:
- Is the property dated and dirty inside?
- Are there structural problems that will put off many buyers?
- Are the kitchen and bathroom areas old and poorly laid out?
- Are there very large bedrooms and living areas that could be remodeled?
- Is the kitchen a separate room that could be altered to an open-plan situation (freeing up an extra room)?
- Is there a separate and large laundry? Could the washer and dryer be located elsewhere?
- Is there spare land that could be subdivided and/or built on?
- What is the zoning on the property? What are the site coverage rules?
- Could you extend the house?
- Could you landscape, make better outdoor living space and/or create better off-street parking?
- Are other properties in the area furnished?
- Is there a university nearby or are you near the CBD? Could the property be remodeled for students or young professionals?
A good property finder understands what types of projects are going to stack up for investors in their local market and are primed to quickly snap up good deals. They have local experts in their network to help evaluate and price up any project work, so you can avoid overcapitalising or creating the wrong type of rental.
Adding value is a fantastic way to build wealth when investing in property, however you do need to understand the market you are serving and invest accordingly.
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