Latest / The Follio Property Podcast / Most Buyers Don’t Know This Renovation Rule | Australian Property Experts

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Most Buyers Don’t Know This Renovation Rule | Australian Property Experts · The Follio Property Podcast

• 0:00
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• 0:56
  Property prices soared by almost 13% last year. Buying and just sitting on real estate for the next three years, don't expect the same returns as what we've had over the last five. I don't think the markets will do the heavy lifting as they've done in previous years.
• 1:13
  What are some of the key things that would add value to the property from a rental yield perspective? It's getting harder to get debt. Income's never been as important because the one thing that handicaps the majority of people is their income. Is there a percentage people need to be looking at? If the market's done 60% or 70%, we've seen examples where we've done 100% to 120% because we've added that value along the way. What are we most excited to talk about? The value add strategy. We always look at how do we activate uplift in an asset so we're not solely reliant on market conditions. That, for me, is the opposite of lazy investing.
• 1:45
  You're listening to the Folio Property Podcast. I'm Rhys Bettle and I'm here each week with my co-host, Lachlan Delahunty. Lachlan, we did it. We've launched the National Investment Report. There's going to be a link in the show notes. Scan the QR code if you're watching it on YouTube as well on the TV. Lachlan, we've mentioned this on the last few podcasts, but we've been loving the Q&A coming through at the moment. Please send us more questions so you can address them.
• 2:10
  Yeah, flood the feed, comment in any question, no silly questions across any topics. I know there's been like a quite a political movement in recent months. There's a lot happening there, questions around that, but also specifically what to invest in, what to look for. If you've bought an asset or about to buy an asset, happy to throw it in the comments. I can give my two cents on what's a good asset, what's a bad asset, throw in some addresses. Happy to address them in our Q&A.
• 2:35
  Off the back of that actually, we had an episode prepared today, but I'm going to shut the laptop and we're going to throw it in the bin and we're actually just having a chat before we started the podcast. What are we passionate about? What are we most excited to talk about? And one of our favorite strategies is the value add strategy.
• 2:51
  Yeah, I think as I've said on a previous podcast, the last five years in real estate in Australia, you've had to make some pretty bad calls not to be in the green, right? The next five years is not going to be like that. I'll be the first to say that. Buying and just sitting on real estate for the next three years, don't expect the same returns as what we've had over the last five. I don't think the markets will do the heavy lifting as they've done in previous years.
• 3:17
  Let's just take it back. For those that haven't listened to previous, because we would have done this early on in the podcast where we've spoken about how to add value and what are some of the things here. But for those that don't know, what is typical of a value-add strategy?
• 3:29
  There's a few different varieties, right? So if you look at some more sophisticated techniques, you look at development. So buying one parcel of land and subdividing that into two, three, four, five, six. There's a larger scale on that again, but for our listeners I think sort of sub five is a really good place to start if you haven't started already. To more palatable development, sort of like retained sub, so where you've got one block and you've got a house on it, you subdivide, cut a bit of land off the back.
• 3:56
  So that's just development in a nutshell for residential. Then you've got value add through major renovations. So we're talking about typically extensions might be a three by one say character home and you extend at the back and turn into a four by two family home. Again, quite a large value add strategy that.
• 4:14
  more micro strategies like cosmetic renovations. And that's probably the preference for those who are investors and it's not their day job out there flipping properties or that's where you got to be really, really careful. If you're not educated or you haven't done this before, you still need to tread a little bit lightly. And that's why we run the program with our clients. It's sort of trying to be that end to end where we can take them and buy the right asset and then add the value for them because it's not for the faint hearted and a lot can go wrong.
• 4:40
  But again, cosmetic renovations is a really good way to add value without overcapitalizing and going and spending, you know, trying to keep the budget under $100,000 rather than going and spend half a mil. It can really go wrong quickly for a lot of people. And then there's more basic sort of value add where it's extremely cosmetic where you're just looking at touch-ups like painting, flooring, gardening. And it's very much almost like a band-aid solution, but that in itself can work.
• 5:05
  There's other forms of that when we're looking at value add through increasing cash flow. We're looking at adding other properties, so like granting flat solutions or increasing rents through increasing the use of the property. So like room sharing, those sorts of things. So yeah, it's a good place to start, Rhys. Yeah. Yeah.
• 5:21
  Let's touch on, so you've mentioned quite a few there. Let's look at the average punter, so maybe not the higher end. I know you like to throw out examples like Donnie and Deb or something like that. That's my mum and dad is John Canberra. That's their name, so there's no need to laugh.
• 5:37
  Is it actually? Well, Dad's not. It's David, but he's nicknamed Don. Apologies, Mr. Delahunty. So let's talk about the average punters out there. So maybe not more on the high end. Now, some of the examples you said at the back end, the touch-up cosmetic ones, I'd imagine that's mainly more a home seller trying to add a little bit of value before they put it to market. Or would you see that strategy being implemented from a renting perspective as well?
• 6:02
  We need to look at the strategy and we talk about strategy a lot. So if I'm going to hold this for a period of time, say north of three years less than 10, when we look at that, we go and do the analysis. If I'm going to go spend $50,000 on the property, what's the uplift in rent and what's that rent over the holding period of the property? So let's work that over a 10-year period. If I'm getting an extra $50 a week over 10 years, what is my return on investment? Without even looking at the capital growth.
• 6:28
  So, the capital growth is, you know, if we spend a dollar to make three, I spend $50,000, I've increased the value by $150,000, huge tick. But it's also the cash flow increase over that period, which when you're building a portfolio and we're seeing that it's getting harder to get debt, so trust lending's out of the equation, debt to income caps now at six times, income's never been as important because the one thing that handicaps a majority of people is their income.
• 6:53
  because they don't want to work any harder necessarily, although they're working hard enough as it is, they want their money to work for them. So how can we, rather than taking on another job or doing a side hustle, how can we get the property income up, which will give them more serviceability? So that's a strategy we endorse quite often with our clients.
• 7:08
  I think what you just said there was gold. I actually took a bit out of that. I've never even heard you speak about that. But have the strategy up front before you do the uplift because if you've got a strategy where you're going to be exiting in a short period of time, maybe it is just that light touch cosmetic that's going to get you the most value you possibly need. So I think that's a really good, really helpful where you need to be from a strategy standpoint before you go in and maybe make a mistake and over-leverage yourself with renovations.
• 7:37
  Without a doubt. And you know, and this is where people get it so wrong. I just find so many investors just go to a barbecue and chat to a mate that's made money in property and they're like, I've got to invest. And we talk about strategy all the time, but you need to go into this with your eyes wide open and with a clear strategy because otherwise you're not going to maximize the return on the investment that you buy.
• 7:58
  So if you go in there with a buy-halt strategy and you activate the renovation strategy straight off the bat in year one with no forecast about how the impact on that is on rental returns, you just want to increase the property value. You go out there and spend a couple hundred thousand dollars on a really nice renovation and turn a three-by-one to a three-by-two, do the flooring, the carpets, the painting, kitchen, and then you go and rent it out for three years.
• 8:25
  What do you think renters do to that property? They've got no care. That's not their home. So when you take it back in three years' time, because you haven't really had any strategy in mind, you've got to go and spend another $50,000, $60,000, $70,000 to get it ready for market. So you wouldn't do that if you had an exit strategy, a shorter horizon on when you're going to exit.
• 8:42
  You might uplift certain parts of it to increase the rental yield, but you're not going to put the flare on it like you would when you're going to take it to market. So I've gone through that recently myself with a property that I sold. I went through various phases of renovations, right? So it was a three-pronged attack in terms of what I did to increase the yield of the property, be that turn it from a three-by-one into a four-by-two.
• 9:06
  But if I looked at it and had my time again, I would have held off on phase three until I was about to sell it. Because everything I did in phase two, polished all the floorboards, stripped them back, painted the entire dwelling, spent $30,000, $40,000 on the gardening, landscaping, because it was getting to look fantastic. Then I put tenants in there.
• 9:24
  I had to redo all those things again. So I went and spent another 20 grand on the floor, another 20 grand on the painting, another 30 grand on the landscaping. I would have just saved that until I was going to sell it. But my strategy on that property wasn't clear enough, wasn't defined enough in terms of when I was going to exit. So yeah, I'm not perfect.
• 9:40
  But if I, you know, anything that I buy now, I buy with a very clear strategy on the time horizon where I anticipate to hold. Obviously, things change and things might pop up. But it will give me a better chance of success knowing and implementing a strategy before I purchase it than buying something and then go, I'll work it out as I go.
• 9:59
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• 10:59
  Yeah, there's some pretty key mistakes as well that I'm sure many people watching or listening to this that have gone down the same route have probably made the same mistake. What about it? You know, you're mentioning there from a, let's just say someone's unsure of what their strategy is. So if they haven't spoken to a professional, just heard from their mate at a barbecue, want to get into the market, there's a.
• 11:18
  an older asset type, they can add value to it. They just, at this stage, maybe they're a bit switched on. They don't want to make a, they don't want to do crazy renovations to begin with. They will do the light touch that you mentioned. What are some of the key things that would add value to the property from a, I guess, a valuation perspective, but mainly from a rental, rental yield perspective? What are some of the key things that would increase a rental yield?
• 11:39
  So the key things for rental yields, Rhys, and this is looking at the amenity. So again, if it's a medium to long-term hold, where we can activate additional accommodation and or wet areas, bathrooms, is key. And that doesn't mean you need to go and spend $200,000 and put an ensuite in another bedroom in.
• 11:56
  But looking at ways to convert, say, a two-by-one with two livings into a three-by-two by converting the laundry to another bathroom. It doesn't even necessarily be an en suite. Straight away, you're going to get disproportionate amount of rental return for that asset in comparison to what you've spent.
• 12:12
  Any other additional things like external internal studies that can be reconverted to bedrooms, putting some wardrobes in those, making them appear to be a bedroom. Straight away, you can increase your rent sometimes $50, $100 just by having that additional bedroom, which was a second living study granny flat. You know, we've seen, we've personally, for my own properties, reconfigured games rooms or sleep outs. There's been a shed on one of my properties, which we completely plasterboard, put carpet in there and made it a granny flat.
• 12:41
  So, you know, what a great use of dead space, which was a pretty derelict shed that I could reconvert it into either a living or an external games room. And whatever that use is will essentially be what the tenants decide it to be, that the ability to open that up to a larger demographic of potential renters gives you the opportunity to charge more.
• 13:01
  From a cosmetic standpoint, what's, you know, from when you're doing the renovations, we've mentioned there, you've got a basic one, something that's maybe adding a bit more value where you're talking in maybe the bathroom or converting a derelict shed into a living room. I hope the person's okay that was living in that.
• 13:17
  What about when should the people be looking to do these value adds? Should the investor be just getting in there, sitting on the property, letting some of the equity do the heavy lifting to then pay for these renovations? Or would a strategy be get the uplift? If they've got the capital there now, do the cosmetic upgrades before you start getting tenants into the property.
• 13:37
  It's going to be client specific and I know listeners hate that. It's like, just give me the answer. But it really is because if we've got a client that's equity rich but cash flow poor and needs the additional cash flow to build the portfolio, he can afford to use that equity to reinvest in the property to increase the cash flow, which is going to give him more borrowing.
• 13:57
  But if we've got a client that's got quite a strong cash flow but doesn't have the savings or the equity to be able to put in the renovation, then we might do a stage-prong approach where we sit on the asset for 12 months, get the natural uplift in the property, then pull the equity out to reinvest back into the property and increase cash flow. So it is going to be client-specific and that's why the strategy is so important. And a lot of clients we meet with come in and it's like, all right, I want a development site tomorrow. I want to go get a value-add strategy tomorrow. It's like...
• 14:22
  Okay, why? What's your goal here? What are we trying to achieve? It's to build a portfolio. Okay, let's look at your unique situation. What are the banks looking at? Where are your downfalls in your current situation? Is it lack of equity, lack of cash, or is it cash flow? And is your cash flow going to be hindered? I had a client two weeks ago where looking at accumulation phase, but they're going to go from two incomes to one.
• 14:44
  So straight away, we have to be pretty clever around that. Okay, we need action some things now because their risk appetite's a lot higher, but their income's about to drop. So we probably need to action some of those steps during the accumulation phase a bit earlier in the portfolio than wait two down to one income because the bank's going to look at that very, very differently.
• 15:00
  So it is, it's client specific and there's no right answer. The same property for a different person is going to have a different strategy and a different outcome. For me, historically, it's been around buying the asset, giving it 12 months or sometimes six months to get an uplift in the asset, using the equity from that property to reinvest in the same asset.
• 15:20
  But at times when I hit cash flow constraints, I've got to fast forward that because I want the rental uplift to pretty well have that mortgage covering itself. So when I go to the bank to buy the next property, they can go, okay, well, that's self-servicing. We'll give you another X amount of debt to buy the next investment property.
• 15:38
  We talk a lot about on this podcast in terms of land to dwelling ratio in terms of a value perspective. So acquiring a property, making sure majority of the value is in the land over the dwelling. Is there a percentage people need to be looking at? Or for instance, if they're trying to add value to a property that's on a smaller land size, would that be something that needs to come to the strategy in terms of how much they should be spending on their renovations?
• 16:02
  As a default rule for the marketplace, minimum you want 60% land to value ratio. And that's just for the buy and hold strategy. That's not the value add strategy. That's buy and hold. So what does that mean, guys? If you're going to go buy a property, have a look and you can easily do your own feasibility on that to say, okay, what would the cost, replacement cost of this house versus the land or what is the land price of selling for in the area? Adopt a square meter rate. You can work out that. And if it's below 60, 40, move on and find something else.
• 16:31
  The problem with that is a lot of the people that they're buying, they don't even realize that they're buying 70% or 60% the other way where they're paying 60, 70% for the house and leaving only 30% for the land value. But for the value add strategy, our benchmark for that is minimum 80, ideally 90%. So we want at least 80%, minimum 80% of the total value of that property is in the land. So there's a very small proportion of value allocated to that house.
• 16:55
  And then our job as the value add strategy is to go in there and convert that from 20% to 30% or 40% where the market will pay for the additional use of that house. And that's where you get sort of unmatched returns because you've got the market increasing in value and then you've got the improvement value through artificially adding value ourselves to increase the property prices. So you've sort of got two market forces working together and that's where you get unparalleled returns.
• 17:22
  Let's go the next level up and looking at more the retain and sub that you mentioned earlier. When would that be the best strategy for someone? And I know you're going to say, you know, it's going to be depending on their circumstances. Or what type of asset or location are they going to be looking at for that type of strategy? Yeah.
• 17:37
  It's not going to be a first-time investor, probably likely not second. And if I looked at an order which you want to do this, because you're going to get cash price constraints. If you go and get a retained sub, you're going to get a yield probably less than 3.5%. Cost of money is at 6% and you're only getting a 3% return. Gross return, net return on that's going to be like 1%, 1.5%.
• 17:54
  So you can probably only buy one of them and your cash flow is going to be pretty restrained. You buy two and you're absolutely maxed out and then you're just hoping and holding and you probably have to subdivide and sell a bit of land to keep you in the game. So it's not for your first, probably not for your second asset, but if you've done some of the more stepping stone value add plays, cosmetic renovation, to increase cash flow along the way, maybe on your third or fourth, you can start to increase your scope of value add and that's when you start to go in the development.
• 18:20
  So, and that might mean you might have two or three assets in the portfolio at a lower gearing level. So your cash flow, you're not cash flow neutral, but you're certainly not significantly negative, which will allow for a retained sub and then you can afford to take on some negative cash flow to underpin that development. Because if you go and buy a retained sub, you're sort of nine months away from getting the approvals. I encourage people to do that right away because it gives you some flexibility. If cash flow is getting tight, you can still sell some of the land.
• 18:45
  and keep the house either long term or pay down the debt so it's positively geared. My strategy earlier in my career was only buying retained subs, but I had to activate those subdivisions quite prematurely to pay off the debt on the front house so I could get the cash flow up to be able to continue to fund my developments.
• 19:02
  So it's a good strategy and I'm in this every single day. So it's a good strategy for some more sophisticated and active investors, probably not for those that aren't doing this every day if they're going to do it themselves. If you're going to pay an expert or an advisor or a buyer's agency to do it,
• 19:18
  do that, as long as they've got experience in doing that, absolutely, that's the way to go because it saves a lot of time and heartache because things do go wrong. You might buy on the wrong site and you think you're subdividing and selling it and it's got a sewer easement going through the middle of your retained property. You can't build on it. I've seen so many examples of that. We've got clients who've got portfolios and I've got development sites and then we've done some due diligence and it's like, well, you've got a zoning compliant development site, but you
• 19:43
  yeah, the sewage easements or there's power easements and or they haven't been completely across the codes of the area that you actually can't subdivide. So again, it's definitely more of an expert. If you look at beginner, intermediate and expert, beginner, basic renovations because of cosmetic upgrades, intermediate, more major renovations, maybe ancillary improvements, be that granny flats. If you look at expert, you're really looking at developments and making sure you're doing your due diligence because there's more mistakes made in that space than
• 20:12
  than any other than the previous two strategies.
• 20:15
  And just on that, the more expert retain and sub strategy, would an investor go in and likely do a cosmetic uplift on the current place? We get the planning permissions in play, but actually not activate that subdivision and obviously improve the yield because you mentioned that these types of assets are going to be very poor on the yield perspective. Is that a place, sit on it, let the market do the heavy lifting, then in three, four years' time, then look to activate the retain and sub? Yeah.
• 20:43
  I'd activate the approval right away because it's valid typically for some states two years up to five years. So you've got the flexibility if something happens. And it happened to me, right? I got hit massive cash flow constraints when COVID hit. I was able to sell two of my rear blocks of land on two retainer subs to keep the front houses. And I'm glad I did because they increased value by 50%, 60% post that. Some people might get forced into a cash flow constrained area. And if they don't have that flexibility, they have to sell the whole lot. And we don't want to be selling the farm, right?
• 21:11
  So definitely activate your subdivision approvals early. Doesn't mean you sell them. You've got the approval sitting there for a rainy day. And then absolutely, again, depending on your strategy, but highly encourage increasing the retained house because you're going into typically...
• 21:29
  a low yielding asset so if there's some quick fixes to that to increase the yield over the long term because under that strategy that front house in those scenarios you typically don't sell them because you you know typically in quality locations fundamentals are strong at a point in time lower on leverage because you've used the sale of the land to pay some debt off on the front so with that in mind doing some major works up front to increase the yield is actually often quite the quite a responsible strategy
• 21:56
  You speak a lot about lazy investing, sometimes good assets, but lazy investing. What do you mean by that? I think lazy investing is, and we had this discussion with Jack Henderson, right? He just goes and buys properties in the East Coast of Sydney and just holds them for the long term. I think, you know, as a professional, we have an obligation to do more than what the market does. And most of the market just buy, hold and hope, right?
• 22:20
  So when I say lazy investing, it is just doing that, just going in a market that you're familiar with, typically within five to 10 Ks of where you live and just buying and holding for the long term with no research, due diligence or understanding on the cycles. So for us, we play the cycles. We try to buy in the low point of the cycle, ride the uplift. And if you can't retain, sell, reallocate funds at the low point of the cycle. And that's a form of progressive investing.
• 22:48
  The next point of that is doing more with the asset than just buying, putting a 10 in there and waiting for the market to solely do the uplift. It's adding value. So regardless of market conditions, whether they're going up backwards or stagnant, you're adding value and increasing the use of that property, but more importantly, increasing the value of that property and along the way, increasing the rental returns of that property.
• 23:09
  So, I look at active strategies as the forefront of what we do at Folio. We always look at how do we activate uplift in an asset so we're not solely reliant on market conditions. But then what's true when you time the cycle right, you buy at the low point of the cycle
• 23:27
  Then you activate a value add strategy, you get unmatched returns because you've got market uplift plus you've artificially increased the value of the property through a renovation, development subdivision. If the market's done 60% or 70%, we're seeing examples where we've done 100% to 120% because we've added that value along the way.
• 23:46
  That for me is the opposite of lazy investing. It's very much active investing and it's not for the average punter. It's for a lot of people that aren't sophisticated, that aren't in the market every day. Sometimes the best thing you can do is just behind your backyard because you're comfortable with it and you're familiar with it. And over the long term, over 20, 30 years, you're going to do okay. Just with inflation alone, you're going to do okay. But for me personally, for you, Reece, for our clients and our staff, we need to be doing more than that. And if we're not, then we shouldn't be in this industry.
• 24:17
  How much does – you mentioned there, obviously, you're looking at cycles. You're going to add value. Doing this strategy, you're going to get the cosmetic uplift. You're going to add value to that property. But if we can get at the bottom of the cycle, then you're also going to get the uplift from the market doing the heavy lifting. How much does construction costs come into play? So just for those – we've got a heavy Perth audience at the moment. Construction costs are through the roof.
• 24:39
  We have an office in Melbourne. We're in Melbourne quite frequently, speaking with the local builders there. The margins are nowhere near what the Perth market is at the moment. How much would construction costs come into play or is it all about timing the market when you should be looking at this sort of strategy?
• 24:54
  So when you buy properties at the low point of the cycle, typically what you find is construction costs aren't as significant as what they are at the high point of the cycle. So your example about Perth then, as an argument suggests, we're higher to the top of the cycle than we are to the bottom of the cycle. So it's not surprising that the cost of construction is much higher than it is in a market at the low point of the cycle, which is Melbourne.
• 25:14
  So, if you look at what we were able to do in Perth, we timed the market extremely well. We activated a lot of our value add strategies early in the cycle when construction costs were far less expensive than they are now. So you sort of get the double benefit.
• 25:29
  of time in the cycle, right? Activating the value-add strategy and paying much less for it early in the cycle than you will at the top. But what you find at the top of the market is that if those works had been done, you're going to get a disproportionate return on your investment because that $50,000 renovation now cost $100,000, but the market will pay you $200,000 for that renovation. So again, your $50,000 investment, your 3X'd it because of market conditions. So it's
• 25:55
  It is important, but yes, if you are going to do this exercise, it's always important to do the feasibility analysis to make sure that I'm spending a dollar to make two, ideally three. So you're not going to go out there and buy a property anywhere. We'll go to Geraldton and buy a property for $700,000, I'll throw $200 in and expect to get $950,000 or a million bucks. If the market's not willing to pay for it there, then don't spend it. It's working at what we always look for in our suburbs that we're buying, Rhys, is what we're buying this for. If we're going to value add, what's the market?
• 26:24
  paying for the uplift. A great example is one that I recently bought with my brother actually in Geelong West and we were able to buy a character dwelling in Geelong West, three by one for $750,000 and Nextdoor had just been sold after a renovation extension for $135,000. So straight away we looked at that and go, okay, well, if we spend $250,000 on this property, can we get it comparable to Nextdoor? And the answer was, yeah, we wouldn't be too far off.
• 26:52
  So it gives you a fair bit of wiggle room when something's sold for 1.35. We bought this for $750,000. Budgeting $250,000, you don't have to be an expert to work at. That's probably not a bad deal and not a bad strategy. So that's what we're doing for our clients is looking for disproportionate exit valves. So what's the market paying for finished product? What does it cost us to get into the market at a base level? And then what are renovation costs within that market? Because you get a lot more for $250,000 in Geelong than you will in Perth at the moment. I can promise you that.
• 27:20
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• 27:49
  What's your top tips for anyone looking to implement the value-add strategy in 2026? Have a plan and have a strategy before you do it. Don't go in blind because that's the worst thing you do because you'll just run into – you'll end up buying pretty good assets that you can't hold long-term because the cash flow constraints will be too significant. Because you're going in there and bought a dump and think you've got a good deal and then you're like, oh my God, I don't know where to start on this. And sometimes they can be the worst money pits. Yeah.
• 28:16
  So if you're not an expert, pay an expert, be that an advisor or a builder, to make sure you know what you're getting in to do before you buy it. Because that's what I find some people do. They try to get the worst house on the best street. But if you have to knock it down, that wasn't a great exercise. And I got close to buying one of them recently, but I went through with the builder and it was to the point of no return. So the cost to redeem that house wasn't going to be worth the investment.
• 28:38
  So it's a fine balance. But having a clear strategy and speaking to professionals, be that property advisors, qualified buyers, agents that know this space and or builders, just go in prepared because it's a, like I said, it's an advanced strategy in comparison to just buying and holding. So like anything, there's more risk, which typically results in the potential for more return. But you've got to go in there educated or working with someone who knows what they're doing. There you go. Off the cuff, some of our best work. You've been listening to the Folio Property Podcast.
• 29:17
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• 29:45
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