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overcapitalising

WORRIED ABOUT OVERCAPITALISING?

Don’t let the thought of overcapitalising hold you back from building that home of your dreams.

In the real-estate world, ‘overcapitalising’ has become a catch-phrase with a nasty taste. And although many Australian homeowners mightn’t fully understand the term, it’s something we’ve come to think of as a looming possibility with every home build.  Is this instilled fear justified?  Let’s take a look and see…

We get it: building a new home is exciting and also a bit overwhelming.  Especially if this is the fulfilment of a life-long dream!  And there’s no doubt about it: the costs do add up quickly when you start talking about service connections, landscaping and permits, and then, of course, the home itself.  So, to make sure you get the best out of your investment, let’s take a look at what overcapitalising actually means.

What is overcapitalisation?

To put it simply, it’s the name given to the situation where the amount of money invested in a particular property is greater than the market is prepared to pay for that property.  For example: Imagine that Jack buys a property, gets services connected, builds a home on it and completes landscaping.  By the time he’s completed the project, it’s cost him $1,000,000.  Within 12 months of completion, Jack lists his property on the open market, only to find that nobody is interested in paying more than $800,000 for the place: Jack has apparently overcapitalised.

Before we go any further, there’s one thing we want to make clear: in this blog, we’re not referring to bank valuations.  Bank valuations are a completely separate thing.  A bank valuation is based on what the home would sell for in a fire sale – banks are not looking at long term investment. And that’s why it’s not uncommon for their valuations to be less than the cost of the home.   Just because the bank values your home at $600,000 when it cost you $750,000 to build doesn’t necessarily mean that you have overcapitalised.

What’s the overcapitalisation rule?

There’s a simple rule of thumb when considering whether you’re likely to overcapitalise on your home, and it’s the 3 W’s: WHERE, WHAT and WHEN.

Where

Location is undoubtedly the biggest factor in overcapitalisation.  At present, a lot of our customers are building homes in the massive growth areas north and west of Melbourne, and north and west of Geelong – areas such as Trentham, Daylesford, Woodend, Kyneton, Teesdale, and Bannockburn.

If you’re unsure about how ‘go-ahead’ or popular a particular area is, there are a number of ways you can find out: real estate agents, townspeople, family, friends, and any other connections in the area can help you establish whether the location you wish to build in is prospering.

Given that you’ve established that your area is a good one, we now dig down to level two: the local level.  Just because a town is known to be a growth area doesn’t mean that every street in that town is going to be perfect to build in.  Let’s put it out there: every town has dumpy streets or ‘bad areas’.  

If you choose to build in such an area or street, it will obviously have a negative affect on the real estate value of your property and put you at risk of overcapitalising.  In short, you must analyze the individual block within the growth area – there is no fixed guarantee that every block within a specific ‘growth area’ is the perfect place to invest.

What

Here we’re talking about the product: the home itself.  There are three aspects to consider on this point:

  1. size – how big it is
  2. style – what it looks like
  3. design – the layout of the home

If these three areas are all well thought out, they will significantly increase the value of the home. Generally speaking, what is traditional, customary or ‘the norm’ is what holds value.  Why? because it appeals to the bulk of the population.  Modern fashions, McMansions, and state-of-the-art design will date quickly and won’t retain their monetary worth.

Things that are likely to lead to overcapitalisation are:

  • spending excessively on appliances – it’s not hard to spend $20,000 on the cooktop, dishwasher, ovens etc, but this won’t add much value to the home itself
  • catering to personal taste – painting the home in exotic colours, installing unusual carpets or benchtops, or going out on a limb with unique or even crazy design features in the home

When

Once you’ve established ‘where’ and ‘what’, the ‘when’ can be the make-or-break: the difference between whether you overcapitalise or not.  Ask yourself “how long are am I going to live in the home for?  Is this an investment that I intend to live in for 2 or 3 years or is this the home that I intend to stay in for the rest of my life?”  If this is a short-term investment, you may be at risk of overcapitalising; if this is your long-term family home, it’s very unlikely that you’ll overcapitalise.  

So, what is a good return on investment? Unfortunately, there’s no one-size-fits-all answer to this question.  Ultimately, it needs to be more than you’d receive if you invested your money in the bank (which at the moment is low – only about 2-3%!).  These days, 10% p/a is considered a good return on investment.  However, once again, talk to people and do your research.

For many Australians, building a new home is a journey of a lifetime!  And it’s one you want to enjoy and get the most out of in every respect.  That’s why it’s important to get and follow advice from your financial adviser at every point.

The Hensley Park Homes country style is one that is guaranteed to hold value: classic and timeless beauty that never goes out of fashion.  You’ll love it, and so will everyone else!  A quality home is hard to beat and when it’s traditional, stately and elegant, it won’t fail to impress.  The ultimate foundation of capitalisation is when the market loves the product and is prepared to pay for it.  A beautiful and traditional home on a nice block in a growth area will steadily increase in value.

Don’t let the whole thought or concept of overcapitalising hold you back from building that home of your dreams.  It’s your house, so follow your gut instinct.  You need to love it: nobody wants to be in the situation where they actually don’t like the home they built, albeit they didn’t overcapitalise. This is your home: your place to relax, enjoy family and friends and spend time off the grid!

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