How to avoid over-capitalising

Recently I went to a house auction in a hot inner-west Sydney suburb that turned out to be a fizzer due to the owners over-capitalising.

The only bid came from the vendors, and it showed the house had clearly been priced out of its market.

It was a lovely home but the price was just too high.

It seems that recent renovations and redecorations had pushed its value - at least in the eyes of the sellers - to well above what the market was prepared to pay. It was either a case of over-capitalising or vendors becoming too greedy.

Only a few weeks earlier a home a few doors away, virtually a wreck with potential, had achieved the very opposite: a gang of bidders and a price well above reserve.

The new owners plan to renovate and extend it. They should take note of their unsold neighbour's house in deciding what work to do and how much to spend.

Our homes are usually the biggest investment we will ever make and most of us do not want to devalue them. But if we improve a property beyond its resale value, over-capitalising it, we have done this.

To avoid over-capitalising, do your homework before you renovate or extend.

For example, if the owners of the home that failed to attract a bid at auction had researched their neighbourhood, they would have realised the price they wanted was considerably more than had been achieved in any nearby sales.

Most of the surrounding houses are single level with two to three bedrooms; this was two storeys, with very steep stairs, four bedrooms but only one bathroom.

It also had quite an odd layout, with a front room, originally a bedroom, turned into a small, rather isolated lounge room.

Maybe some of the considerable sums spent in an extension and upmarket redecorating would have been better used in improving the room flow, making the stairs more user-friendly and putting in a second bathroom. Before renovating, it's important to consider the housing styles and demographics of your suburb and recent sale prices.

When it comes to deciding how much to spend, work out realistically what price you could expect to achieve once the renovation is completed.

For example, after researching nearby sales you conclude that $600,000 is the most you could expect for a three-bedroom, two-bathroom house in your area.

Next add the expected cost of the work (be realistic and include everything) to the purchase price, plus 5% for landscaping and perhaps another 5% for contingencies. If this comes to $675,000, you are spending too much.

Look at cutting down on the most expensive items.

Stone floors are costly but you can achieve the same sort of look more cheaply with polished concrete. Pre-fabricated kitchen cabinets expertly fitted can look virtually as good as custom-build joinery but cost much less.

New kitchens and bathrooms usually deliver the best bang for your buck, as they greatly improve the value of a home.

But even here you need to be aware of the standard in your area.

A luxurious marble bathroom with gold fittings may look fantastic but will not add nearly as much value as it costs if it looks out of place and makes the rest of the home appear shabby.

Attractive, user-friendly and easy-to-maintain outdoor areas can also add value, but swimming pools often don't.

Home loan tips

Think beyond the rate. Shop around and don't limit yourself to one of the big banks.

You may be surprised by the features and competitive rates available from other lenders. It's important when comparing loans that you are aware of all of the upfront and ongoing fees.

Know how much you can afford to borrow and think about having a buffer.

Consider fixing part of your home loan and leaving the other part variable. This can be particularly useful if you require the stability of regular repayment amounts.

Consider if the loan has an interest offset account available.

Simply depositing your day-to-day money into one of these accounts can help reduce the interest charged against your home loan.

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