Understanding the renovation property formula by Patrick Bright
When renovating there are literally hundreds of improvements, big and small, that people can make to increase the value of their property. The trick is to add more value than the actual cost of the improvements writes Patrick Bright.
The biggest mistake I see renovators make is failing to consider the needs and wants of their prospective tenants or buyers. When renovating for profit, it’s important to create a property that tenants want to rent and buyers want to buy. You have to begin with the end in mind.
Renovating is more than marble finishes, soft lighting and designer furnishings; it’s a people business, not a property business. You can do a first-class renovation but if the property backs onto a rail line you’ll have trouble renting and selling it. That’s one of the reasons why property selection is so critical.
The Renovation Profit Formula
The theory behind renovating for profit is what I call ‘the profit formula’. The formula is like the filter through which you view a property, so it’s important you understand it thoroughly BEFORE you start looking for properties to buy. It helps you to determine the potential profits in a property and thus set a maximum buy price.
When you’re assessing a property renovation deal, always try to calculate what the value of the property will be once you’ve renovated it. Then subtract your total renovation costs which are all the costs of taking the property to that finished state from where it is today. Now work out your purchasing costs and subtract them. This is your break square figure. If you purchased the property at this price you make no money. But every dollar you purchase below this figure is potential profit in your pocket.
In a nutshell the renovation profit formula is: End value, less renovation costs, less purchasing costs is your breakeven. Every dollar below that breakeven point is potential profit. It’s important to note that the total renovation costs include the holding costs and the buying and selling costs if you decide to sell the property. Here’s my 7-step plan for renovating property for profit:
STEP 1: UNDERSTAND THE RENOVATION PROFIT FORMULA:
Whilst the renovation profit formula is a simple equation, determining the figures that you put into this equation is critical and takes skill and experience. You must be accurate when assessing the value of a property post renovation and itemise all renovation costs.
STEP 2: WORK OUT HOW MUCH YOU CAN AFFORD
You need to have enough saved to cover the three major costs of renovating: the cost of buying the property, the cost of renovating the property and the selling costs or the ongoing costs to hold the property.
STEP 3: TARGET THE RIGHT PROPERTY TYPE
Match your risk profile and ability to the right type of property. Before buying a property to renovate it is important to consider your risk profile carefully, including how comfortable you are with the possibility of losing money, or that the return may not be as high as you had hoped for.
STEP 4: MARKET RESEARCH AND PREPARATION
This involves identifying suburbs and the types of properties within those suburbs with the greatest profit potential, researching property values, brushing up on design and decorating, and selecting a team of quality tradespeople.
STEP 5: SELECT THE RIGHT PROPERTY TO BUY
Look for a property with profit potential. Your first consideration here should be the condition of the property. As I explain in great detail in my Renovating for Profit book you’re better off searching for something rundown, but not totally derelict.
STEP 6: PAY THE RIGHT PRICE
Work out the maximum you can afford to pay and still make a healthy profit. One of the fundamentals of renovating for profit is that you buy well. If you’re not skilled in negotiation it would be a good investment to hire some help from a buyer’s agent.
STEP 7: GET THE WORK DONE ON TIME AND BUDGET
Avoid profit-shrinking cost overruns and delays. Make sure you use a spreadsheet to schedule the works. You need to ensure all the tradespeople do their work in the right sequence. Always add a buffer of a day or so around each tradesperson. This gives you wiggle room if there are delays.