Overcapitalisation: Is it really a big deal?
If you have been to one of the numerous property investment seminars that have been doing the circuit over the past decade or so, chances are you have heard the term ‘overcapitalisation’. There is also a chance that you have been told that it’s potentially a very bad thing. But is it really that bad? Is it really something that you should be worried about?
Well if you’re developing a property with a view to selling it quickly for a profit then yes, overcapitalisation is a very bad thing. But if you’re building a home to live in for a number of years, then chances are you might not need to concern yourself with whether or not you have overcapitalised.
What Does Overcapitalisation Mean
To better understand this, stop and think for a moment about what overcapitalisation really means: It simply means that you have spent more money on your home than you would be likely to recuperate if you put your home on the market once your property was completed.
But if you have no intention of selling your home in the near future, then chances are the extra you invest now will be offset by the growth in property prices over the coming years. And given the way the property market in Southeast Queensland, chances are it will not take many years before your property is worth significantly more than you have invested.
So many people have become so hung up about overcapitalisation that they go without many of the things they ideally wanted, just to keep their property at somewhere near a realistic sale price, yet they have no intention of selling it in the next 10, 15 or 20 years. By that time the extra they could have spent to have everything they ever wanted might have been more than offset by the growth in property prices.
When Overcapitalisation is a Good Thing
I have known people to cut back on their home wish list on properties that they never intend to sell. They have built or bought homes that they intend to live in until the day they die, and yet they cut back because they might be overcapitalised! Overcapitalisation is ONLY an issue if you intend to SELL your home, providing you don’t go over the top. If you’re not looking to sell, or have no plans to sell in the next 5 to 10 years, then chances are it is not something that you should lose any sleep over because you are doing it to improve your lifestyle now.
To give you an example of this, clients of mine purchased a property in Coorparoo for a little over $300,000 in 1999 and then invested a further $300,000 in renovations. Certainly, at the time the renovations were completed they had ‘overcapitalised’. But when they put the property on the market only 4 short years later, it sold for just under $800,000. Not a bad return on investment in just 4 years.
The most interesting part of this example is that they invested in getting me to create a quality design for them. The beautiful design, coupled with the growth in property prices, meant that whilst they may have overcapitalised initially, it took very little time for the property to grow in worth well beyond their initial outlay.
How to Prevent Extreme Overcapitalisation
Of course, there are limits. If you buy a property for $700,000 in a street with homes all of similar value and then spend 3 to 4 million on renovating it, then chances are you might never recoup your investment. But as long as your level of investment is within reason, then there is no reason to not create a home with everything you have ever wanted.
Of course, if you are concerned then you should talk with your accountant and/or financial advisors, but if you intend to live in your property long term you might find that you have very little to worry about.
So whilst you may have heard horror stories about the pitfalls of overcapitalisation, if you intend to live in your home for any length of time, chances are the extra you invest in creating your ideal home will have little bearing on you in the long term.