Do you have tenants moving out and are trying to decide whether to renovate your property or make improvements before the next tenants move in?
Is it time your property had a bit of a spruce up but you are wondering if it is indeed worthwhile?
The key to answering this question is to look at the return you will receive.
Do you know how to work out the potential return on improvements to your rental investment property?
The easiest way to do it, is to estimate the rent increase per year after improvements are complete, and divide that into the cost of the renovation.
Eg. You renovate your kitchen between tenancies and spend $7k. As a result, you are able to obtain a higher rent. Let’s say, $20 per week. To work out your return, calulate the rent increase over a whole year ($20 x 52 weeks = $1,040). Now divide that into the cost of the renovation ($7k) and you get 0.149. You can look at this as a percentage (or just multiply by 100) = 14.9%.
Better than a term deposit!
In this post, I’ll take you through the math behind making improvements and hopefully show you why renovating your rental property can be one of the best investments you will ever make.
Some owners think it’s not worth bothering. Reasons not to renovate include:
- It’s a rental property. If I put new chattels and fixtures in there they will just get worn out anyway. Why bother upgrading it?
- If I upgrade my rental property it’ll be nicer than our own home!
- I don’t know enough about renovating. I’m not sure who to talk to or where to start.
Before you spend money on anything, it is important to consider your opportunity cost. Eg. what else you could spend your money on instead,
First up, let’s take a look at a few standard investments to provide a comparison.
At the time of writing (Feb 2019) the best available rate for a term deposit is provided by Rabodirect at 4% per annum.
The other alternative for most NZ homeowners is to pay off your mortgage. Most 1 year fixed rates are around 4%. So essentially, if you are able to put any extra money towards paying your mortgage off you are earning 4% return on your money (you won’t have to pay interest on that money in future). It’s even better than that though since you don’t pay tax on this ‘return on investment’, while on term deposits, you pay tax on the money you earn.
So that 4% return you earn by paying off your mortgage is equivalent to a 6% return on any other investment where you have to pay tax.
So let’s say you have some excess money, maybe an inheritance, gift or work bonus. If you have a mortgage then paying off that mortgage, rather than putting the money into a term deposit, can earn you a 50% better return (4% untaxed vs 4% taxed), or in other words 6% vs 4%.
This article is not about helping you find ways to up the rent in a market where tenants are under the pump. This is general advice for owners who charge a fair rent for their properties.
You should add a heatpump and as much insulation as you can anyway without upping the rent.
Lets say you spend $3k on a heatpump and as a result, you can increase your rent by $10 per week.
$10 per week is $520 per year. $520 / the initial investment of $3k is 17%. So by investing $3k you are earning $520 per year. In other words, you are earning 17% on your money. More than 4 times better than a term deposit. Crazy, right?
How much more rent could you earn if you upgraded your kitchen & bathroom? Let’s say you invested $15k but could achieve $50 more per week in rent. That’s $2,600 per year, which is a 17% return on your original $15k.
Let’s say you could add a garage for $30k, but could charge an extra $60 per week in rent as a result. That’s an extra $3,120 per year, or a 10.% return on your initial investment.
Not only that, you are adding value to your property at the same time!
Key points to be aware of:
Based on the numbers above, it would appear that renovating your investment property can be a really good investment. There are some key details to consider though…
The initial value of your investment is held in the property. You can’t easily take the money out again if you need it like you could with a term deposit. get the $30k back out once you spend it on the house but you can refinance!).
Also important to note that the value of the renovation drops over time. Eg. if you add a new kitchen, you’ll need to add another one in 20 years. Improvements like a garage may provide a lower return but will last a lot longer.