Podcast: Why First Home Buyers Can't Buy a Do-up And What the Opportunity Is For Investors | Ep. 225

Posted by Ed McKnight on 27/04/20
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Show Notes

What's Covered in the Show?

In this episode, we discuss why first and second home buyers often can't buy a do-up and why that presents an opportunity for property investors.

A common misconception is that when first home buyers purchase a do-up that they can borrow the renovation costs as well ... because the property will soon be worth more. That's not the case, you cannot borrow renovation costs, unless you already have more than a 20% deposit.

That means that low-deposit borrowers (primarily first and second home borrowers can't afford t do a property up. But, they could afford to purchase a more expensive property that has already been renovated.

We also mention our upcoming property investors webinar where we will teach you how to get more money from the bank and grow your property portfolio. Sign up to the webinar here.


Transcript of the Podcast

Ed McKnight: Hello and welcome along to the Property Academy podcast. I'm your host Ed McKnight and I'm Andrew Nicol, and today on the show, we're talking about the capitalisation of renovations and what this actually means for first and second home buyers.

Now this can be a little bit tricky to get your head around but bear with us. Now, Andrew, what do we mean by this and what are we talking about today?

Andrew Nicol: So, this is something that comes back to my experience as a mortgage broker. I would always have clients, first time buyers, when I was patient enough to deal with them, who would come to me and they'd talk about buying a property that they had, you know, had good bones, but they wanted to do it up to kind of increase the equity.

And there was always this misconception that they could add their renovations onto their mortgage, which is not true. So, any cost of your renovations comes out of your own cash. So say for example, someone were to buy a property worth say $600,000 they need to have their say 20% deposit, we'll call it, so 120,000 and the renovations were going to cost 50,000, they need to have 170 K cash. And so that made it a lot larger challenge, or a lot bigger challenge by having a much greater deposit, than if, say someone was buying something that was already renovated.

And so why this is quite an important thing to consider is if you're ever going to sell a property, which has you know good potential that you think you might sell to a first time buyer because of where it's price in the market, or also maybe a family who you think, well, you know, I won't do the renovations. I'll let them make those changes themselves. That may be more valuable if you go ahead and complete those renovations, allowing people to come in with a lower deposit.

So, to put that into some numbers, let's take that same example of a $600,000 property where you put 50,000 in. Let's say, after those renovations, the house is worth 700,000 so you would actually make 50,000 along the way. So that's a good benefit to begin with.

But if you're selling that property now to a first home buyer or a person buying their second house and upgrading, they only need $140,000 deposit being 20% of $700,000 so they can actually borrow against those renovations because now they're incorporated in the value of the house, and so that makes it more attractive and gives you more buyers potentially that you can sell that to even at a higher purchase price because they can enter the market with 140 rather than 170 cash.

Ed McKnight: And this becomes even more apparent and a larger difference if they're borrowing at 10% so if we look at that 600 K property and the first home buyer was going to borrow at 10% then they would need a $60,000 deposit plus $50,000 to do the renovations. So that's a total of 110 K.

But if an investor comes along and sells it now for $700,000, after doing the 50K renovations, then they only need 70 K worth of deposits. So that's a $40,000 difference for first and second home buyers. And look, one of the things we know when we looked back when Kāinga Ora or, the Housing Commission, got changed at the end of last year, one of the biggest constraints, especially in the main centres Auckland, Wellington, Christchurch, or at less so Christchurch, but Auckland, Wellington is, they've got really good incomes first and second home buyers.

They've got great incomes, but they're low on deposit because houses are so expensive. And so that's why, you more often than not see first and second home buyers looking at things that are already renovated than things they need to renovate themselves. It's not just that millennials don't like to get their hands dirty. It's that the financing doesn't work. If they do the renovations themselves unless they're able to get help from somebody else, from the bank of mum and dad in order to be able to finance those renovations so they can do that work themselves.

Now this is going to be really useful as well, just to think about for people who have held property. So, you might not be a renovator, you might be somebody who's always invested in brand new properties, but hey, look, you're getting to 65 and you've held a property for 20 odd years. Now that property is going to still have good bones but be a little bit more tired than the equivalent property that a first-time buyer could go and purchase or second home buyer could go and purchase.

So it may be worth your while if you're in that strong equity position, which would just seem you would be in order to go hire some people to do those renovations, get it all done nicely, sell it back onto the market, and you may actually find that even though you're selling at a higher price, you've got more buyers interested in that property.

Andrew Nicol: And actually, on that note Ed I'd like to mention that from experience, what I've seen is that people have a very hard time valuing or seeing potential. So when you go into a house and there might be the ability to change things around a little bit or tidy it up by replacing the carpet, putting a fresh lick of paint on, people don't really see that value. And actually, they see it as more of a pain.

And so, while we say, Ed jokingly said that millennials don't like getting their hands dirty. They don't. Certainly, if someone has, you know, a husband, wife and a couple of kids they very much might not want to do any renovations. They might want to move straight in because doing renovations with kids is going to be a nightmare.

So if you can make it as easy as possible, both from a financing perspective and from a just transactional standpoint where people can just move straight in, you will get the maximum return on that sale price, which for most investors who are selling back into the market is really important.

Ed McKnight: And this is similar to, we did an episode only about two or three days ago talking about Golden Homes, and I kind of mentioned this idea of capitalisation just for anybody who hasn't listened to that.

We were talking about how Golden Homes properties tend to be little bit more expensive but have better bones because they invest in things like door hinges and things like that. And what we were saying is, look, the idea is that this works really well. If any future maintenance is then capitalised into your purchase price.

So, let's say they spend an extra 20 grand or so on it, and you pay for that now rather than later and 10 years in terms of maintenance or avoiding maintenance. If you pay for that now, when you purchase the property, you need a lesser deposit. You'd only need to find $4,000 in order to get the extra 16 K worth of lending in order to make up that 20 K.

Now, if you do that in 10 years time where there's 20 Ks with of maintenance or deferred maintenance, that needs to be done, you've got to find all of that 20 K in order to be able to do it because it's not capitalised into the house. If I've understood that right, Andrew. Always just want to make sure just in case, so otherwise I get told off afterwards.

Fantastic. Well, let's wrap it up there, but please don't forget to rate, review and subscribe to the show. It really does help us get the message out to more people and hey if you want to learn more about how to go from two to five properties, which of course was the most popular topic that came from the property investor survey that we did, then why not come along to our webinar this Tuesday, 7:00 PM Andrew's going to be talking about exactly how you build your portfolio from two to five and then beyond properties.

Thanks for listening to the Property Academy podcast. I'm your host Ed McKnight and I'm Andrew Nicol, and we're going to be back again tomorrow with more daily strategies, tactics, and insights to help you get the most out of the New Zealand and property market.

Until next time