With television shows like The Block, that highlight Aussie’s love of renovating, anyone would think flipping property is a great way to make some money in real estate.
However, when you break it down and look closely at the numbers it’s clear that turning a profit on a renovation is not an easy feat and compared to a simple buy and hold strategy it might not be the best option for many.
Renovating for Profit
The idea of renovating for profit is simple enough. Buy a property, give it a cosmetic renovation which might include a new kitchen and bathroom, some paint and floors and then quickly onsell it to a keen buyer.
What most fail to notice is that the costs of transacting property in Australia are high, so you really need to have your numbers right or you’ll very quickly find yourself with little or no profit at all.
For example, if you were to purchase a property for $1 million, your upfront stamp duty costs will already be around $40,000 plus another $5,000 for legals. If you use a buyers agency, you might have to spend another $20,000, so your purchase has already ended up costing you $1,065,000.
Then when the time comes to renovate, you’re likely going to need to spend around $100,000 to put in a nice kitchen and two new bathrooms as well as do the painting and all the other small things that add up.
If you can then onsell that property for $1,250,000, which would be a 20% uplift in price, you’re still only looking at making around $50,000 profit after you take out the fees for the sales agent and settlement.
This is all before even considering holding or interest costs and also the fact that you have to pay capital gains tax on your profits at the full rate if you sell it in under 12 months.
As we can see, our profits have quickly evaporated and we are left with around a 5% profit on our $1 million purchase.
For most Mum and Dad investors out there, a far more superior strategy is to simply buy a great asset and hold onto it.
Based on the averages alone, we’ve seen that property in Australia has grown at a rate of around 6.5% over the past 20 years. With that being the case, we can make more profit by simply buying well and holding and it also takes a lot less time and energy.
In this example, we are also assuming that we are buying an average property in an average area. It’s very possible to buy well and locate properties that outperform the average for many different reasons.
Renovating vs Asset Selection
The reality for most people that look to renovate for profit is that there is ultimately very little profit that is left over at the end of the day.
That said, there are still some good reasons to renovate as a part of a buy and hold strategy. Renovated properties will likely see higher rents, therefore making it easier to hold and service the debt.
Similarly, you can still profit from a renovation indirectly, by holding the property and cashing out some of the equity through refinancing. This way you also avoid many of the selling costs and also capital gains tax.
Generally speaking, those that profit from renovations do so by buying properties well below market value. For the most part, your blue-chip locations that see the strongest capital growth, rarely see sales that are far below their true market value. This is because these areas always have healthy demand.
Most renovators who have turned a profit have generally been the beneficiary of a strong market with much of the gains coming from capital appreciation alone.
So before undertaking a renovation, it’s important that you get very clear on your goals, the numbers involved, and if it is really going to be worth your time and energy when a buy and hold strategy would likely be superior.