Peter Churchouse is the founder of Portwood Capital, a leading real estate investment company. With more than three decades of experience in real estate investment and research he is widely considered one of the world’s foremost authorities on Asian real estate markets. He is also author of The Churchouse Letter, his financial newsletter which provides investment and wealth building strategies. In this 8-part series, he highlights key rules he feels investors should follow when purchasing real estate. This is Part 3 of the series.
You’ve heard this one before.
The good location will underpin the price over time.
But crucially, taking on the worst house in a good neighbourhood can give you lots of upside.
You can give the property a makeover to bring it in line with its peers in terms of quality. Done right you can really add a lot of value here. This is where big gains can be made. It’s where I’ve made many multiples of my initial investments. By adding value.
It can be via renovation of the entire building. It might be just a case of repainting the property, maybe cleaning up the gardens. Sometimes it is possible to add to the building - installing a pool, an attic in the roof, a sun-room/conservatory, a new garden, "granny flat" over the garage, an underground wine cellar.
The trick though is not to over-capitalise the property by spending more than the uplift in value is likely to be. It is easy enough to make this mistake, so be vigilant on cost of upgrades and assess what the likely upside on the price is going to be in relation to the cost of the work. The increase in value may be tied to an expected increase in rental income potential.
CASE STUDY: Adding Value – “The Second Leverage”
The “First” Leverage is your mortgage debt. It’s Rule number 7 (we’ll get to that). It’s putting $20 down for a $100 house. I call the process of adding value “The Second Leverage”. Why? Because you can make big capital gains on a small investment.
I have deliberately tried to keep this little guide ‘short’ on numbers. But we need to do a little bit of math here so please bear with me. It’s a simplistic example, but the figures speak for themselves.
Let’s say you have 2 near-identical apartments in the same area. Owner A puts his on the market for rent asking US$1,000 a month. You, Owner B, decide to invest $10,000 to upgrade your apartment. You put in a new kitchen, some good lighting, and an elegant paint job. You list it for US$1,150 a month.
Let’s assume residential property yields are 5.00%. This basically means if a real estate investor wants to come along and buy your rented property, he’s looking to receive 5.00% of the purchase price per year in rent.
Owner A’s apartment rents for $1,000 a month. Or $12,000 a year.
$12,000 a year is 5.00% of $300,000. So this is his selling price.
You, as Owner B, have given your place a real facelift. You’ve invested money to do so. And you’re getting $1,150 a month. Or $13,800 a year.
$13,800 a year is 5.00% of $345,000. This is your selling price.
You invested $10,000 into your value adding renovations. And now you are looking at a $45,000 return on that investment.
Adding value can magnify your initial investment many times over.
Whenever I’m looking at potential properties, the questions are automatically on my mind… “Where can I add value here?.... How can I improve this property?.... How can I make someone happy to pay more to live here?.... And how can I do that for a minimal cash outlay?”
A subtle variant of this theme is to buy a real dingy property in an area that is not necessarily yet at the top of its game, but is up-and-coming. New transport infrastructure is often a big value add to an area. I have seen examples where the development of a new underground rail link can produce an uplift in value of 20% to as much as 40%.
Development of a new large scale comprehensive development in a neighbourhood can also drive values of nearby properties skywards. Property developers know this and will often buy up smaller properties surrounding their own projects in order to upgrade the use and physical condition of these which in turn adds value to their larger project.
I have seen numerous examples of low rent, low value uses being replaced by much higher value uses as a result of the development next door of a major new shopping centre, office building, multi-use complex. The car repair workshops and air conditioner maintenance shops give way to fashion outlets and Starbucks outlets.
Large scale public sector driven urban renewal projects very often result in upgrading of nearby areas. Yes, these can often take a long time to get done, but the value add will accrue, often without your doing anything much yourself.
We see how some neighbourhoods undergo a "gentrification" sometimes simply due to the pressures of demand placed on a desirable nearby neigbourhood. The up-and-coming district simply experiences the spillover effects of pressure on existing popular locations. Bar and restaurant districts can be great targets for the "spillover effect" concept. They have a habit of spreading outwards from their core.
This concludes Part 3 of the series. I know that if you make an effort to follow even a couple of the rules that I outline in this series, you will be in a better position to successfully invest in property. If you have any questions or comments, I’d love to hear from you. You’ll find my details here.