2 prerequisites for improving your investment property
My clients often ask me a very basic question. Why invest in improvements on their investment properties? Improving or upgrading an asset is only done to ensure that its value and cash flows that it produces are either maintained or increased.
It is imperative that a financial analysis is conducted before improvements are implemented. If there is no demonstrable financial return emanating from the improvements and upgrades, then they should not be undertaken.
Let’s assume you have purchased an apartment for Dh2 million which can be rented in its current state for Dh160,000 providing a gross yield of eight per cent. You may consider improving the kitchen with new appliances, remodelled benchtops, storage areas and sink configuration and upgrading the bathrooms with new tiles, sanitary ware and water fittings. The total investment for the improvements and upgrades, including labour, totals Dh200,000, resulting in a revised capitalised value of Dh2.2 million for the apartment.
Before you commit to such an investment, calculate carefully if you are getting a return on your investment and if you will be maintaining the gross yield from the investment. If the apartment can only be sold for Dh2.1 million after six months, then the improvements have not realised a return on the investment. In addition, to maintain an eight per cent gross yield on the new capitalised value of Dh2.2 million, you must raise the annual rent from Dh160,000 to Dh176,000. Assuming the rent cannot be raised, then the gross yield will drop from eight per cent to 7.2 per cent, erasing any rationale to invest in improvements and upgrades in the first place.
This is called “overcapitalisation” which is, in effect, an economic phenomenon whereby the valuation/price of an asset is superior to its ‘real’ value, usually defined by the market.
The pre-requisites for improving your investment property are:
1. The investment can be recouped if sold within six months;
2. The gross yield of the property asset is not unduly affected.
If you are positive that the prerequisites are satisfied, there are a number of improvements and upgrades that you might consider.
> Improving and upgrading kitchens can provide solid investment results if the property asset is likely to appeal to families with a full time housewife. Beware of improving and upgrading kitchens for properties that will appeal to young singles or couples who are more likely to eat out more and spend less time cooking.
Bathroom remodelling should be completed to provide a hygienic, easy to clean, low maintenance bathroom that provides plenty of storage. This is the bare minimum. Most tenants will not tolerate a bathroom that is dysfunctional, hard to keep clean and already degraded with mould and decay.
Additional storage areas are always welcomed by tenants and can be provided inexpensively.
Proper lighting design and fitting of the correct light fixtures can be an affordable way to give your property the ambience to enable you to command a higher rental. Ambience is important when presenting property, particularly larger properties like villas, townhouses and three-bedroom apartments.
> Landscaping can make a big difference to how your clients’ property is perceived. Remember that first impressions count and it’s imperative that potential tenants have a positive impression about your property.
> Building swimming pools can be a little tricky. For a start, it is very easy to over invest in a swimming pool. While generally, tenants will be prepared to pay a little extra rent for a swimming pool, they will not discern between a 20,000 litre or 30,000 litre swimming pool while the investment required for the latter can be up to 50 per cent more.
> Installing wooden flooring can be an investment trap. There are many types and the price and quality range from the very cheap for fake wood to the very expensive for real wood. The problem with wooden flooring is that it can wear very quickly requiring significant maintenance. Where possible, I suggest you stick with tile flooring. > Providing additional parking, particularly in areas where onstreet parking is difficult, can be a very worthwhile investment.
> Creating entertainment areas for children will always appeal to families. However, it is easy to over invest in a playground as you must ensure that it is of high quality materials and construction, of a safe design and accept that regular maintenance is mandatory.
> Adding security systems and fencing the property will go a long way to increasing the sense of security of your tenants.