October 22, 2014 by Dymphna 20 Comments

Reno Rule#1: Buy low, pull to the middle

Working Tool

When thinking about manufacturing growth through renovations, there’s a principle I always keep in mind:

“Buy low and pull to the middle.”

The ideal is to take bottom rung properties and bring them up towards the middle of the market.

In a market with a $500,000 median price, you’re probably going to do better renovating for growth with a $250,000 property than you are with a $750,000 property.

It’s an ideal in the sense that it’s not a hard and fast rule. Sometimes you might see an expensive property where you can add a lot of value easily.

But generally speaking, we’re going to get more bang for our buck with properties towards the bottom of a segment’s price range.

I know this will make intuitive sense to a lot of people, but it’s worth understanding why it’s the case.

First up, we tend to think about renovations in absolute dollars. A new kitchen will increase the property’s value by 15K. A new fence and a lick of paint adds 5K etc. But when we’re thinking about growth, we tend to think in percentage terms.

So with cheaper properties, you get more ‘growth’ for your renovation buck. $50K worth of improvements on a $250K property gives you 20% growth. The same amount on a $750K property is 6.6%.

While $50,000 dollars is $50,000 dollars, the percentage play gives you a degree of protection.

The difference between a $250K house and a $300K house is substantial (20% in fact). We’re talking about quite different houses.

The difference between a $750K and a $800K house is less material (just 6.6%). We’re talking houses around a similar mark.

So when it comes time to sell, it’s a bit harder to separate your property from similar properties on the market. You can even loose a couple of percent just by selling in the wrong month!

So if you loose a couple of percent – could be market timing, whatever – if you loose it on your expensive property, your down from 6 to 4 percent growth. That means your down from like a 50K to 35K uplift.

But 2 percent on your cheapie (from 20 to 18%) means your only down from 50K to 45K. 5K is a lot easier to wear.

It’s all a simplification of course, but the principle will serve you well. Buy cheap, pull towards the middle.

The other reason why it’s worth aiming for the cheap end of the market with our reno’s is that renovations on cheaper houses tend to be cheaper, easier and offer greater returns on our investment.

A lot of times you can book a substantial gain just buy giving a cheaper place a good tidy. Mow the lawn and straighten the fence and you’ve got ten grand in your pocket.

And these changes are relatively easy to do. Sometimes you won’t even need to get a tradie in.

I like to think about renovations in a sort of hierarchy. At the bottom we’ve got cosmetic renovations like the lawn and fence above. Then we’ve got rejuvenations – same as above, but maybe putting on a new deck or something. Then at the top of the spectrum we’ve got structural changes – knocking out walls to put in an open-plan dining area etc.

As we go up the hierarchy, we go up in price and degrees of difficulty.

And so I always recommend to newbie investors, especially when they’re just starting to dip their toes in the water – always start with something simple! Never bit off more than you can chew.

You’ll learn a lot in the process. Even a simple cosmetic touch up has many lessons to teach you.

And you’ve got enough on your plate when you’re starting out – entry and exit costs, contracts, getting a property ready for market. None of it’s rocket science, but when you’re starting out, it can seem like a lot.

It can be overwhelming.

So the last thing you want to do is take on some Taj Mahal type reno, with multiple tradies across multiple time-lines. Don’t do it to yourself. Start small and simple. There’s enough time to become some Backyard Blitz superhero down the track if you want to.

So cheaper properties tend to offer investors more opportunities for simple, cosmetic renovations, which give you the chance to make some real gains off a minimal investment.

Properties above the market average price rarely offer simple cosmetic reno opportunities. If they’re above average, then they’re probably already well-looked after and well-maintained.

Renos are more likely to involve major structural changes. Again, that’s not to say that it’s not worthwhile, but you need to know what you’re doing, and it’s probably best left to seasoned investors.

Finally, holding costs on cheaper properties tend to be smaller. Even just thinking about foregone rents. If you’ve got to leave the property empty for an extra 3 months, because the plumber puts a jackhammer through the water-main or whatever, and renovations run over time, that’s going to hurt you less on a cheaper property (where rents are cheaper) than it would on a more expensive one.

Again, none of it’s rocket science, but when you’re starting out, it’s worth remembering the principle of buy low and pull to the middle.

It’s a rule of thumb that’s served me well.