Overcapitalising on an investment vs a home – is there a difference?  When does overcapitalizing matter and when is it forgivable?  What the outcomes could be if you find yourself in that position?  Those are just some of the questions we pose of Cate Bakos.
Transcripts:
Kevin:   Overcapitalization is a term that strikes fear into many people who do renovations and property investors, but you know, there is a time when overcapitalizing doesn’t really matter. You can be forgiven for it. That’s according to Cate Bakos, who’s a buyer’s agent. She’s very well versed in this. Seen it happen, I guess, on a number of occasions. Good day, Cate. How are you doing?
Cate:   I’m good. Thanks Kevin, how are you?
Kevin:   Good. So, when is it forgivable?
Cate:   Wow, good question. I used to think it was never forgivable, but it is. If you’re a homeowner and you’ve got the house of your dreams and it’s your forever home or it’s at least your long-term home and you spend money on it to personalise it and to suit your own needs, so that you and your family can completely enjoy it, I think that’s forgivable. It’s only when people go to sell a property, particularly if the sale was unplanned, that overcapitalization can bite them because obviously, they might not get what they put into the property when they sell it. But, when you’re not selling, then the property value, the property worth, is just on paper and if you’re getting extreme enjoyment out of it, then how do you put a price on that? So, that’s the first one that I think is completely forgivable.
Kevin:   What are the areas you see people typically will overcapitalize in?
Cate:   Putting things in that are a value add to them, but not a value add to others. So, for example, a swimming pool. I can have a buyer looking for a family home and it might have a beautiful pool with landscaped yards and the pool room and the decking and everything that makes it quite phenomenal, but if you’re not into pools or if you don’t want one and you’re looking at getting rid of the pool and covering it over, then that’s a gross overcapitalization that means you’ve added zero value to the home. But, if you’re enjoying your pool and you’re enjoying it for decades, then it’s certainly a value add for you.
Kevin:   Are there any examples you can give me, Cate, where as in investor you might overcapitalize as an example?
Cate:   You might have a property that in its current state is not necessarily attracting the right tenant or it’s not attracting enough numbers of applicants, so you’re facing higher vacancy rates or you’re not getting the ideal tenants in the area. And so, by equipping the property with some high-tech or higher end finishes, you might find that you’re reaching that vacancy period gap and you’re getting a really good quality tenant. Now, you might find that you’re not actually getting a lot more rent, but in cases like that, if you’ve made a decision to hold the property for long-term growth and you believed in the area, then overcapitalizing on the property to get the right tenant and maybe to have no vacancy periods or to increase your rent slightly, could be a good move. But it needs to be a long term hold because if you’re doing it for short term, then you’ve really got to ask yourself whether you’re better off getting rid of that property altogether and buying a different type of property.
Kevin:   I guess it’s a bit like taking a backwards step to take two steps forward, but it’s always a long-term plan, Cate.
Cate:   That’s exactly right. People need to look at it like that. If it’s a long-term buy and hold, then sometimes spending that extra money on a property that you feel is not entirely deserving of it is a wise move if you’re getting a tenant and you’re getting the right kind of tenant and you’re getting the right kind of rent.
Kevin:   Just in closing, Cate, if I can raise one that would probably be a dilemma for many people. They might have found themselves in this situation. They’ve bought what they think is a great investment property only to find after the purchase that it’s not so great and they’ve got to spend money. At what point …
Cate:   Yeah.
Kevin:   … do you say I’ve got to stop because I am overcapitalizing?
Cate:   Well, if you’ve bought a property here, there certainly is a point where you’ll decide enough’s enough, but the reality is if you’ve bought a property with invisible issues, they could be structural issues, could be reshaping the roof, it could be removing asbestos, it could re-plumbing, rewiring electrical. All of those things have particularly big tickets associated with them when it comes to cost and fixing the issues, and that can really send an investor into a spin. They’ll be wondering whether they bought a lemon, whether they’ve got a dud, will they ever get their money back? You’ve really got to look at it objectively and decide at what stage is this not representing a viable asset for you? If you get everything scoped together and you find that you’ve got a difficult property or a bit of a dud, then you may have to face the prospect of selling it, but you need to be aware that if someone does their due diligence and finds those issues, you’ll be facing a reduced sale price.
Cate:   So, my philosophy is that if all of the metrics were there in terms of location, desirability of the type of asset in that particular area, and if you think that it’s representative of a good investment in terms of long-term growth and getting an ideal tenant, I would invest in the property and I’d do it well. And I’d hold it until the long-term, chalk it up as a bad experience. The lesson in that is due diligence. It really is important to make sure that you have someone look over the property, so that those expensive invisible issues are highlighted before you sign the contract.
Kevin:   Absolutely. Due diligence is one thing, but I think also going in with your eyes wide open, as opposed to being wide shut.
Cate:   Yeah.
Kevin:   In other words, go in with the worst case scenario. What would happen if I purchased this property, then I found I had to make some capital improvements to it? What situation would I be in? And, if it’s that you couldn’t do it, then maybe you shouldn’t do it, Cate?
Cate:   Really good advice, and people who are looking at older style properties have to accept that there’s pros and cons to that. The pros is that often the older properties in the established areas represent better capital growth and sometimes, they’ve got a really beautiful inherent style, it might be an old art deco. But you need to remember that anything that was built in 1920 that hasn’t had things updated or replaced is definitely going to give you a big bag of issues to deal with, so it’s not having unfair expectations of an older property as well.
Kevin:   Great stuff. Cate Bakos, who is a buyer’s agent, always tremendous advice. Cate, catch you again soon. Thank you.
Cate:   See you later, Kevin.