Reno Stuff

From: Michael Croft

What follows is a reply to reno questions/email which I thought may interest some of you.

It’s a tough one and marginal from my perspective, but it all depends on your strategy. Based on the figures provided I would anticipate little or no growth for the next 3-4 years in either cap gain or rents. Can you sit around that long and wear a 1 – 2 % interest rate rise as well? Or is there something more productive you could be doing with the money?

Personally I am looking for a combination of long term good growth and cash flow. Over the next twelve months I anticipate lenders will tighten their criteria anticipating a rise in interest rates and a possible fall in property values in some areas/types so a possible tightening of LVR’s too. Also the valuers are under attack from their professional indemnity insurers; the premiums have skyrocketed and risk management has become a primary element of a practice (read increasing conservative valuations). All of this means you need to; buy well, add value, increase cashflow, minimise outgoings and so on, so that the gods and lenders smile on you.

If you have money to burn (as this one is neg geared), are confident of your research and the cap gains in the long run, and it fits your game plan, or there is redevelopment potential, etc it may be worth pursuing. 7.6% average cap gain in the last 10 years is OK, a 4.2% gross rental return (acquisition and reno) is not good but may be for the area? We consistently (30 year average) achieve 8% cap growth and 9% plus for gross rental return. I say this not to impress you but to impress upon you that both high growth and rental returns are possible (find/read ‘Well done Geoff!!!’ on the forum). The potential to add to value and rent is the key ;-) Multiple income streams from the one property eg house and flat, a stunning and cheap reno, a combination of the two, etc.

If you really have your heart set on this property (and you know you shouldn’t buy on emotion) and as you say they are not motivated, pay their price on your terms. Eg. go for a 6 month settlement with unrestricted (and vacant) access after exchange. Solicitors hate this but do the reno before you settle, organise the tenants before hand as well and have a revaluation before settlement. Please note this is not a recommendation to buy this specific property.

My answers are not very specific or helpful so ask any more questions you have. I don’t buy to a specific set of criteria, if the numbers work I’m happy, but some rules of thumb are; I like don’t wanters, slightly above the median price for the suburb, good land component 30%+, multiple income streams are a bonus, good reno potential (I like them dirty and run down but structurally sound), redevelopment potential is a bonus, all the usual on any property selection checklist – quiet street, close to CBD, schools, transport, etc. There are always trade offs to be made as no property is perfect - as with most things in life it’s a matter of balance.

A note on the numbers; if they work i.e. capital growth and rental return are high, most of the other stuff falls into place, all you have to watch out for is the anomalies eg. Demolition orders, future council resumptions, structural issues, etc. these your solicitor and your research/due diligence should pick up. I’m not a control freak (really truly) but if I don’t control the body corporate I don’t buy strata.

Anyway good luck with it! Michael Croft.
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Reply: 1
From: Jacque Parker


I really, for one, appreciate your informative and interesting posts. They provide me with much food for thought. A question or two for you..
Doing so many renovations, how do you cover these costs that aren't covered by the borrowings (ie; renovation costs). I would imagine that on such large purchases of unit blocks, you would be limited by your LVR and thus have to come up with bigger than usual deposits?

Do you get the cost of the renos added onto the loan amount by getting quotes before the loan is approved?

Cheers, Jacque :)
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Reply: 1.1
From: Michael Croft

Hi Jacque,

I use Bank Guarantees (I have used deposit bonds), go for a long settlement (3 to 9 months) with unrestricted access (not always easy and solicitors hate it), revalue before settlement, and if I've done it right (about 90% of the time) I can get 100% finance on the purchase price and acquisition costs, and usually (that's where the 10% failure rate comes in) the reno costs as well.

Worse case (that 10%)I am out of pocket the reno costs which seem to come in at about 5% of purchase. The after reno value takes care of the LVR, including acquisition costs (stamp duty, legals and so on) etc included.

Michael Croft
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Reply: 1.1.1
From: Michael Croft

I should have added that LVR's on a block of flats is comparatively easy if not strata titled. This is because by creating the body corp and sep titles you have increased your market base and hence the price of the individual units. It's a rare case of the parts being worth more than the whole. Think of it as buying wholesale and creating the ability to sell retail.

So a block of 4 before strata $880k, after reno and strata $1.35m (real example and reno plus strata cost 75k). LVR and borrowing no longer an issue as it's no longer a 'commercial' proposition but 4 individual residential properties. There are traps for newbies the most important of which is that the property must be able to be strata titled with little or no modifications or your budget will blow out big time. Also doing renos on 4 at once can swamp the new players and they crash and burn - with the consequent big $$$ losses.

I should add that I have seen 3 of these deals in the last 8 weeks, so they are still out there. One is a little beauty which I am working on right now ;-)

Michael Croft
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Reply: 2
From: Simon St John

Michael, Thanks for your posts - great.

Just a couple of questions:

- How easy to get a vendor to agree to 6-9mths settlement with vacant possession? Is this one of the hard parts of putting the deal together?

- What is a Bank Guarantee and how does it work?

- You mentioned that newbies crash when taking on, say, a block of four. I wasn't clear why. Are we likely to underestimate costs of reno and have cash flow probs? Or is it to do with the amount of work involved?

- What are a couple of big items that might hit you in converting to Strata - you mentioned this but I was wondering if you could give an example?

Again, many thanks for your posts!

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Reply: 2.1
From: Michael Croft

Hi Simon, and sorry for the slow response.

Negotiation is the key, trying to create that win/win is never easy. The long settlement doesn't usually present a problem as you are normally buying from an investor. Often the property is an inheritance/deceased estate sale so they can afford the time to maximise their sale price.

The vacant possession is sometimes tricky as the vendor wants the continued income. One way around this is to take over the rent payments whilst your doing the reno. The rents are usually low as the property is most likely run down. It comes down to numbers and factoring ALL costs in the equation.

A bank guarantee functions not unlike a deposit bond only issued by your lender. It assumes you have assets/equity are of some standing with them etc.

Like most things in life you crawl before you walk before you run before you ride a bicycle before you drive a car ( yes I do know a girl who learnt to fly before she could ride a bike or drive, but the exception does not disprove the rule). An overestimation of one's ability and an underestimation of the work/time involved usually stuffs up the best of reno potential. The bigger the potential gain the bigger the potential to stuff it up and lose (usually).

The biggest item is compliance with the current building codes and "triggering" the BCA. Some older did not have to comply with 'minor' issues like fire safety and are impossible to get to comply and are bulldoze jobs (not good for cash flow). This is of critical importance when converting to unit title.

All the usual disclaimers apply, seek independent professional advice etc. etc.

Michael Croft
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Worst Books

Reply: 2.1.1
From: Jas

There have been many people asking for the best property books to read,
so I thought I'd turn this around.

What books have you read which weren't worth the paper they were printed

The worst for me was one I borrowed from the library. Written by an
American couple who had been investing for just over a year, the book
showed their investment philosophy. Buy as much as you possibly can,
charge heaps to tenants and push the price up each year. They then
outlined the tricks they used to do this.

The book was published in 1987, so my main thought was wondering how
they survived the market crash...

You know the market's over hyped when newbie investors are 'gurus'

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Worst Books

From: Jacque Parker

Sorry to the author but I hated RESIDENTIAL REAL ESTATE INVESTING by C.Thornton. After reading four or five others (WEALTH POWER OF PROPERTY, Jan's books, THE MILLIONAIRE NEXT DOOR some of them that I can remember) it was dim and not at all insightful.
Cheers, Jacque :)
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