posted in: Building Wealth
Should I renovate or purchase an investment property?
In the event that you have some cash freed up or you have built equity in your home, you may be wondering which is the best way to invest that money. Many people will choose to either buy an investment property in order to build wealth or invest that money in a renovation to improve their lifestyle and add value to their home. So, which is the best choice?
The simple answer is – it depends. There are advantages and disadvantages to both options, and this will entirely depend on your unique circumstances. Here are some of the pros and cons.
Pros of renovating
An advantage of renovating your home is that you get to improve your circumstances and quality of life without needing to move. This is often very desirable for people who have created connections in their communities and with neighbours, have their kids in good schools, and don’t want to leave. Many people love their home, it’s just not quite working for their circumstances or their growing family. Renovating allows you to hold onto the home you love, while making it even better.
Renovating increases the value of your home without you needing to upgrade or move. Depending on how substantial the renovation is and the cost of that renovation, you may find that the cost of renovating is less than upgrading, making it a more cost effective option. This is particularly true when the renovation adds bedrooms or bathrooms, or otherwise impacts an area of the home that is known to add significant value.
Given your principal residence is exempt from capital gains tax, investing in your home makes sense from a capital gains tax perspective if you ever wish to sell in the future. Plus by staying put and not relocating, you’ll save on significant upfront cost of stamp duty.
Cons of renovating
One of the disadvantages of renovating is that if you borrow money to fund the renovation you will need to service the debt without the advantage of rental income to cover it. That means your cash flow will be affected.
Another key disadvantage of renovating is the risk of overcapitalising. If you spend too much on a renovation and the increase in property value doesn’t exceed the cost of that investment, then you will have reduced the overall equity in your home. In this instance, you might have been better off selling your home and then buying an already renovated property on the open market. Not only might you have saved money, but you also wouldn’t have had to unnecessarily subject yourself to the stress of renovating. Overcapitalisation is more likely at the moment given the recent inflation on building costs, so it’s important to keep this in mind.
You can also sell an investment property to fund future expenses such as retirement income or school fees, without impacting your living standards. This option isn’t really available to you when you’ve only invested in improving your home, unless your bank will allow you to release equity from your home for these type of expenses, which is often not permitted under most banks lending criterias.
Pros of buying an investment property
The biggest advantage of buying an investment property is that the debt can be serviced through rental income and tax deductions, rather than entirely out of your pocket. In some cases you may be cash flow neutral or even positive, meaning that the investment can accrue capital growth over time without costing you anything day-to-day.
Because an investment property can be located anywhere in the country, you’re not tied to one location when selecting where to invest. This allows inventors to pick a property market cycle that is more primed for growth, not just investing in properties located nearby to where you live.
Typically when buying an investment property you will also have access to more capital then when renovating. This is because when you borrow money from a lender you will typically be able to borrow more when buying property as opposed to renovating. This allows you to gain greater property exposure.
Another advantage is the potential to minimise tax. Negative gearing and the ability to deduct interest and other property costs are advantageous from a tax perspective.
Cons of buying an investment property
One of the disadvantages of choosing to invest in property rather than renovate is that you may be sacrificing a better quality of life in pursuit of wealth. This may not be a bad thing, but it’s important to remember that given the very reason to build wealth is to improve your life, foregoing a better quality of life in the short-term needs to be a carefully considered decision. It can absolutely make sense if the rewards are far greater down the track, but if they’re not or the sacrifices in the short-term are too great, you may want to reconsider.
Another disadvantage of investing in property is that you don’t get access to the same capital tax exemptions as you do for your home. Should you sell an investment property you can get up to a 50% capital gains discount, however there will still be some tax to pay on the gain.
How should I decide?
Ultimately, the decision between renovating your home or buying an investment property will depend on your preferences, borrowing capacity and overall long-term wealth strategy. It’s a good idea to chat to your financial adviser to see which strategy may make the most sense for you.
Need advice on which strategy may be right for you? Contact the team at Montara Wealth for an obligation free chat today.