Residential property investment is very different to investing in other asset classes. If you believe property investment is about “entering the market”, then waiting and hoping for the market to rise, and “exiting the market” then you are leaving it all to chance.
You should seek to take control of your investment and empower yourself to make the right improvement decisions. There is nothing worse than wasting your time and money on improvements that do not yield you a profit. Learn how to be a smart renovator and profit from home improvement.
Different residential property investors have different objectives. Property owners pursue different strategies over different timeframes to achieve their own objectives. Listed below are four of the key property investment strategy alternatives:
|Buy, Improve, Reside, Sell||A popular strategy for an investors who also is the occupier. After purchase they improve upfront and/or over time, live in and enjoy the property, and ultimately sell it when the timing is right. Sometimes they reside, save, and then improve, but the scenario objectives are much the same.|
|Buy, Rent, Improve, Sell||An investor sees the opportunity to buy and immediately rent out the property. They want it to generate some cash over time. When the right time to sell is approaching, they improve the property and exit.|
|Buy, Improve, Sell||This is often termed a ‘flip’ in the industry. The buyer sees an opportunity to buy the property, improve it quickly, and then sell. It is all about maximising profit and minimising time.|
|Buy, Improve, Rent, Hold||This investor is looking to build a property portfolio that generates cash flow. They typically do the essential improvements upfront to maximise rental yield. Over time they can build their rental portfolio and eventually improve them again and sell.|
Each of the four key investor scenarios above involve some home improvement. It is possible to profit from investing in established property without any home improvement by either sourcing a property at below market value, taking advantage of a market improvement, or through positive changes in demand for the property. However, this article focuses on the more traditional planned approach to profiting from improving the value of the property.
Property investment is risky business
It can be amazing to some residential property investors to comprehend the extent of their financial risk. On a typical property investment they exhaust their available savings and use it to pay the deposit on their new investment property. They secure a loan from a bank or finance group to pay for the rest of the cost of entry of the investment property and the expected costs of improving it. They promise the lender title to the property if they cannot repay the loan, and hope they will keep their employment so they can pay the ongoing loan repayments. They are often playing with sums of money that can be more than 10 years of gross salary for the investor.
When you ask new residential property investors what they hope to achieve from their property investment many do not have an immediate answer. However, they have comfort in their property investment decision. When you drill down on what provides that comfort in risking a large multiple of their annual salary there is a fairly consistent set of common drivers:
- An expectation the property market values will rise,
- They will achieve a good rental yield on the property,
- That it is ready to rent or close to it,
- That interest rates will not go up, and
- They can eventually improve the property and sell it for a handsome profit.
I think most readers would agree that not all these expectations come true all the time. Unexpected increases in interest rates, a decline in the property market values, or changes in rental rates are all real risks. Moreover, a negative event like a termite infestation or tenant dispute can really disrupt the expectations you have for your investment. It is not hard to see that you could lose or gain multiples of your annual salary by changes in any of the above expectations.
Many of these risks should be understood before investment. It is not difficult for an investor to assess how their investment might fare under a pessimistic outlook. This will ensure they are properly informed on what events might cause their investment to go sour – and that can influence whether they invest and if so, what they are prepared to pay.
The one key driver of the investment that you should try to estimate is how you might add value from improvement.
Improve value by focusing on what you can control
Firstly, let’s understand what ‘value’ is. When it comes to property, value is basically what you can sell it for in a normal market process. It is what a prospective buyer is prepared to pay for the property, not what the seller thinks it is worth to them. Therefore, it is important to assess what drives value from the perspective of the buyer, as they are the party that is going to determine the price that is offered to the investor.
Value can be impacted by a lot of things outside your control such as interest rates, local development, economic confidence, and property supply in the area. The property owner should focus on the factors they can control to improve the value. There are some important factors during the sale campaign such as property presentation (staging) and the campaign strategy itself, however this chapter focuses on the home improvement opportunity before that.
Value is a perception
When a prospective buyer is assessing value they will come up with a perception of the quality of the property and how the property will meet their objectives. And remember, like everything, first impressions are critical in driving their ultimate perception. It is important to understand what perceived value is. It is the value a buyer attributes to a property or a feature of the property based on what they perceive or believe. A buyer does not have perfect information to do a detailed valuation, so this perception is a function of what they observe, hear, understand and assume about the property. Perceived value can be different for each prospective buyer and can also be very different to actual value.
The assumptions buyers can make are very interesting. Their perception can easily be different from the reality. It is interesting to listen to the conversations and comments of people as they exit an open house inspection. They almost cannot wait to discuss or announce their view on its value. That is their initial perceived value, and it rarely changes much even with more detailed due diligence on the property. That is why first impressions have to impress!
Your challenge is to positively drive a prospective buyer’s perceptions so they are fully valuing the features of the property. Remember they may not see or fully appreciate all the features of the property, such as:
- The premium wall insulation you had installed to make the house cool in summer and retain warmth in winter;
- The technology you have had installed to make the home liveable such as the easily controlled light zones, or the temperature controlled hot-water systems; and
- The installations you have made to ensure the property is low maintenance such as the automatic pool cleaner or the professional irrigation system.
The list can go on and on. Many of the most valuable add-ons in a home are not visible and will not add to the value perception unless they are marketed during the sale process.
However, they are likely to assume that all the features they cannot see are the same quality as the all the features they can see. Therefore the visible features are more important to their perception of value. A buyer’s perception of value is based on what they observe or hear about the property. If the property is full of features that appeal their emotions are high and they are mentally ticking all the boxes.
The safest approach to maximising perceived value is to target a clean contemporary appearance. When considering how to improve visible features think about what would appeal to most people – not what would necessarily appeal to you.
Simple lines, natural light, open spaces, minimalist furnishings, smart storage, and fresh bright surfaces all contribute to a positive value perception. Whether it is consciously or subconsciously the potential buyer is looking for a house they can be proud of. They are visualising themselves living in the spaces and how they would set up the house. In this frame of mind they notice the things they would need to change – the wall between the living and dining areas, the ugly 1970s gas fire place, and the peach coloured vertical blinds. These develop into a list of costs in their mind, which become deductions on their perceived value. Therefore you need to have addressed the obvious negatives and do your best to ensure their attention is diverted to the positives.
Next week we will look more closely at some of the opportunities to improve value and how best to go about it. Stay tuned!