The 3 successful ways to manufacture equity

There are ways to boost capital growth even when the market is stagnant. Jeremy Sheppard explains the following proven methods.

•  Renovate
•  Subdivide
•  Develop

For each of these strategies there are some key principles the investor needs to keep in the forefront of their mind that makes each particular strategy worthwhile.

1.Renovation key principles
A renovation may for example, involve bringing a tired old property up to scratch with a modern kitchen, a new bathroom and a fresh coat of paint.

Renovations work through the concept of synergy. That is, the whole is greater than the sum of the parts. If an old property has many eye-sores, the perceived value of the property may be lower in the minds of potential buyers than the sum of the costs to restore it.

Everywhere the potential buyer looks, there is a problem. This becomes overwhelming if the buyer is not able to break down the list of rectifications and cost them.

Contrastingly, once renovated, the perceived value of a property may be greater than the sum of the money spent to improve it. This time, everywhere a potential buyer looks there might be some “wow factor”.

It’s important to understand this concept of synergy when searching for a renovation project. If the investor’s thinking is that renovation profits come from doing it yourself, then all they end up doing is exchanging their time for money. It’s the same as getting a part time job for the weekend. The serious profits are in using synergy to your advantage.

2.Subdivision key principles
A subdivision might involve splitting a 1000 square metre block into two 500 square metre blocks for example. Each new block can now have a house built on it. The value of the two new blocks together may be worth more than the original single block alone.

Subdivisions are another play on misunderstandings of perceived value much like with renovations. Home buyers may not see much extra value in a property that has extra space. A bigger back yard does mean extra space for the kids but there is more to mow too. The value a home owner places on an extra 200 square metres may only amount to $50,000. But to an investor planning to subdivide it may be worth an extra $100,000.

Every additional 100 square metres of space is almost a waste to the home buyer once it exceeds their minimum. This perceived devaluing of large blocks works to the investor’s advantage so the investor can acquire these blocks cheaply.

After the subdivision, the perceived value again works to the investor’s advantage. The lack of space is still a negative to the home buyer, but it’s not a deal-breaker if they can still build a decent sized home.

Note that a block that is exactly twice the size of other blocks in the street will have the perceived value of being exactly double the price. Similarly, a block that is exactly half the size will be perceived as being exactly half the value. Home buyers can do simple maths, but they may struggle with abnormal or non-even multiples of block sizes.

They key to a successful subdivision, like a successful renovation, will come down to recognising poorly perceived values amongst home buyers for both the purchase price and the post-project price.

3.Development key principles
A simple development might involve knocking down a house and building a duplex. Or it may involve buying a block of land and building 3 townhouses on it.

The principle behind a profitable development project lies in finding under-utilised land. The land may have a house on it but the council planning laws and market would accommodate a block of apartments for example.

The investor may be able to find a property that has excellent development potential that the current owner is un-aware of. However, this case is unlikely since their selling agent will more than likely know of the potential.

The major reason why a seller will not develop themselves is due to lack of funds, lack of experience, lack of time or lack of interest – probably not due to a lack of awareness. This may alter the key principle of a successful development from recognising under-utilised land to instead simply having the experience, funds or determination.

Larger developments are therefore more likely to be more profitable since there will be less people able to fund them. It also means that there could be a direct relationship between success and experience.

Strategy pros and cons
Renovations are quick compared to developments. The skills required to complete a renovation successfully are also relatively easier to acquire than those for a small development. Renovations are a lower risk strategy but also have lower return. That means you may not be able to add as much value.

Renovations are generally cheaper than developments. A lick of paint and some new flooring may only cost $10,000. But even a one bedroom granny flat could cost many times that.

Developments require a considerable amount of dollars, experience and knowledge and have a higher risk. But they come along with higher returns. The value added via a development will usually exceed that of a renovation.
Developments are usually much longer projects. It not only takes longer to build, but just getting approval from council can take many months.

Subdivisions are usually a little more advanced than renovations in terms of expertise, risk and return. However, they are sometimes comparable with renovations in terms of time and cost. Some subdivisions can be comparable in complexity to small developments. In fact a council will probably want to know what you plan to build on the new blocks you’re creating.

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