What is the rule of thumb in overcapitalizing

My wife and I are renovating a 1930's cottage in Lathlain, Perth (between Vic Park and Burswood) which will involve quite a bit of structural work, adding an en suite and a new bathroom and kitchen.

If, for arguments sake, we bought the property for mid $400,000's and want to hang on to it for another 5 years or so, is there a rule of thumb on how much we should spend, or more to the point, not spend?

The house is weatherboard, on a 700m2 block, close to train station, 4km from Perth CBD, freeway and shopping center.

I should add I work in the construction industry so I won't be paying full $$ for anything.

I realize this is a bit of an open question so go easy.

is there a rule of thumb on how much we should spend, or more to the point, not spend?

Generally speaking you should be getting $2 or $3 back in value for every $1 spent on a reno. Also, try to keep your reno costs to 10% - 15% of the purchase price. e.g. if you buy for $400K don't spend more than $40-60K.

However, after doing so, you don't want to make your house worth in the top 10% of the suburb.

Have a read of this thread perhaps: http://www.somersoft.com/forums/showthread.php?t=50515
If you think - post reno - that your house will be worth more than any other in your street (or immediate area) then you've most likely over capitalised.
The quick answer is probably not to spend more money than you can get back. However, in my experience, people also consider the investment in thier lifestyle (much like say taking a holiday) and measure this by saying "on a weekly basis, what is this luxury going to cost me?". In this way, if you were to spend an additional $5,000 on your ensuite would it give you a smile each morning knowing that it's costing you $20 a week for five years? Or would that money make you happier elsewhere?
Whoops I've over capitilised .... Best house in the worst street for my ppor, but I still love to live there

PPORs are different ;) They are an emotional / family based decision.....and not really an "investment" unless you draw down equity out of them for deposits for IP purchases.
The quick answer is probably not to spend more money than you can get back.
That's what I did. I spent about 150% of the purchase price on renos on the last project, mostly DIY so it came out WAY cheaper than getting professionals in.

The renos added about $1 of value for every $1 spent, maybe slightly less in the end. Juuuuuuuuust squeaked in on being breakeven in the end, or would have been if I had actually got a buyer.

Most recent reno we spend about 50% of the purchase price but it added about $3 for every $1 spent, maybe more. Being in a different area we got professionals in for all the big juicy stuff like plumbing and a new kitchen. Had a customer round the other day who knew the previous people living here and they nearly keeled over in shock at how different the house is now :cool: Pretty funny, normally people don't get past our study, this one wanted the grand tour lol
One of the biggest things you have to get to know is your target market and what is going to be of value to them. What is the socio economic demographic? Generally in areas where the median house price is around $400k they are not going to value marble bench tops and bi-fold doors, etc as much as they would in an area where the median house price is $1m and up. So doing one of those things may not add as much to the end price as the cost of the renovation.

So if you go right back to the basics: your
Renovation Profit =
Selling Price – Project Costs

Where the Project Costs =
Purchase price +
Closing Costs +
Renovation Costs +
Holding Costs +
Selling Costs

Renovation cost is only one of the costs in a project and your renovation needs to make sure that all costs will be covered as well as a profit made.

The first thing would be to get to know your target market in the area and what is of most demand to them. Then work out how much they value those different things - ie how much value it is actually going to add to your home if you do them and then when you look at the cost of doing it, you can assess whether you will acually make more from doing those changes then the cost associates with doing them. This sounds easier then it sometimes is, because it can take time to research and track what adds what kind of value in which area.

A good place to start is to capture the details of what you definitely know... Your purchase price, your closing costs, your holding costs (over the 5 years), your selling costs... Then like a few other investors suggested, it's good to think of your renovation costs as percentage of the purchase price. We for example do not spend more then 10% of the purchase price on a renovation unless it is a high end property.

In those cases you might have a home such as a renovation we are about to start in Glen Iris where the purchase price was $985k, the renovation is going to cost just over $120k but the resale will be above $1.5mil. In those cases it is worth spending more on the finishes and fixtures because that is expected and valued by the target market who you will be onselling to.

As an example, have a look at what the homes selling in the $600k price bracket have in them in that area, for ideas of what you could do that attracts that kind of a return. Then find out how much those things cost...

Wishing you every success,
Ana Stankovic