What is overcapitalisation?
As we've discussed before, renovations are a great way to add value to an investment property. After all, Auckland's capital growth is exemplary at the moment, but not every home is going to see the 24.4 per cent year-on-year value increase that QV recorded as a median. Adding rooms or features to your home can boost your value when capital gains aren't as strong as you'd like them to be.
But with every reward, there are a few risks. One issue you need to keep an eye on if you've decided to renovate is overcapitalisation. But what exactly is this?
When you break it down, overcapitalisation is basically when you spend money on a renovation that won't be recouped by the added value. It can happen with any part of the home, and occurs for a couple of reasons. Firstly, you may simply spend money on an addition that is absorbed by regular capital gains - especially if you're holding onto the property for the long term.
The other main way overcapitalisation can occur is if you conduct a renovation that doesn't actually add value to the home in the eyes of the buyer market. You might add in some decadent light fittings that look incredible, but don't actually boost the value of your home by what they cost. You've got to think about it!
How do you avoid overcapitalisation?
Firstly, make sure your renovations are appropriate. If a home already has two bathrooms, you likely don't need to add a third one in. Likewise, expensive finishes and features on an otherwise inexpensive home in a low value area isn't a great investment. Don't over-spend when the property itself isn't worth a whole lot.
It's where professional advice and careful budgeting comes into play. Don't overspend, and get a valuation and home loan help before you make any commitments.
Can overcapitalisation be good?
There can be some instances where spending too much on a renovation is actually useful - for example, if you're committing to a property for the long term. If this is the case, then altering the property to suit your family plans could be beneficial no matter what the cost.