Many homeowners simply have the wrong idea about how to add value to their homes. Many believe that when their home becomes outdated it's a simple matter of renovating the home to restore its usefulness and value. Many homeowners are happy to spend large budgets on renovation thinking it will increase the value of their home.
That is not always the case.
As you will discover in this article the value of the land component of a residential property has increased to the point where the majority of a property's value is the land. The value of the building is becoming negligible. Spending money on improving the building may result in a poor return on investment.
In many circumstances, it is simply not economically feasible to renovate a house.
So let's look at other options that yield a better return on investment.
Firstly, we need to understand the dramatic escalation in land prices in our cities for single family home residential building lots.
The cost of building a new home has dramatically changed over the years.
The cost of building has become more expensive but the cost of land has far exceeded the rate of increase in the construction cost of a new home. And it's even worse when you take into account that average new home sizes have increased over time.
Let's have a look at some real-world examples.
These three homes were built in the same suburb and each property is a single-story home only slightly larger than the last. We built the fences and landscaped the properties ourselves to reduce costs.
My parents built a home in 1987. The land cost $27,000 for a 700 square meters lot. The house with driveway and landscaping cost $110,000 to build. The property cost $137,000.
The land was about 20% of the cost of the whole property.
When I built my first home in the early 1990s, the land cost $52,000 for 674 square meters. Land had doubled in price. The complete home with driveway and landscaping cost $120,000 to build. The total property cost $172,000.
The land was 30% of the cost of the whole property.
When I built my second home in the early 2000s, the land cost $98,000 for 600 square meters. Land had doubled in price again. The complete home with driveway and landscaping cost $145,000 to build. The property cost $243,000.
The land was 40% of the cost of the whole property.
Are you starting to see a pattern here?
The cost of the land is escalating faster than the cost of building a new home.
The land is increasingly becoming a larger component of the total property value. And the average size of a building block is getting smaller with a narrower frontage.
Now in 2021, land in the same suburb is around $500,000 for 450 to 600 square meters. There isn't much land being developed in the suburb and property developers are spoon-feeding the land to the market to keep prices high. The property developers have reduced the average lot size down to 450 m2 and the average frontage size down to 14 meters. This makes it more difficult to build a single-story home as the land is too small. As a result, most new homes are two-story, narrow lot designs.
If I built a new single-story home in the same suburb today the land would cost $500,000 for up to 600 square meters. The complete home with driveway and landscaping would cost at least $260,000 to build. The total property cost would be $760,000.
The land would be over 65% of the cost of the whole property.
In other more expensive real estate developments the land component can easily be over 70% of the cost of the whole property.
The result of this escalation in land prices can mean only one thing. Less land will be developed for single family home style residential real estate. More and more new developments will be higher density accommodation such as, town homes and apartment buildings.
Land in cities has simply become too expensive to justify building small or medium sized single-family homes.
Homeowners that have an old home that requires extensive renovation to bring it back to new need to think carefully about their return on investment.
Firstly, you need to determine the value of the property.
Secondly, you need to determine the value of the land component. What would the property be worth as a vacant lot ready for building a home?
If the home is reasonably close to the city, you will find the land component will be at least 70% of the value of the property. More likely, it's 80% of the value of the property.
Homeowners have to ask themselves, is it worth spending a large renovation budget on the 20% component of the property?
Are you really going to add value to the property beyond your renovation budget?
Many home homeowners have been caught out renovating an old home to find hidden problems that blow the renovation budget and don't add any resale value to the home.
Generally, many homeowners find that the increased value of the home after renovation is less than the cost of the renovation.
Maybe you have an old home in a great location and you don't want to move. One option is to knock it down and build a new home on the existing land. This is good option if other homeowners in the area are doing the same.
However, if old homes are being demolished and replaced with apartments or commercial buildings it would not be desirable to build a new home. You may end up with a new home in between two apartment buildings. This would make your property difficult to sell and further development of your land impossible.
Usually, building a new home on existing land will be worth more than renovating an old home. The new home will be worth the value of the land plus the cost of the new house. Whereas renovating an old home will only be worth the value of the old home plus some of the cost of the renovation if the renovation is done right.
Building a new home has a lot of advantages over renovation.
There are no hidden problems discovered that add thousands of dollars extra to the renovation budget.
Many renovated homes still look outdated and just look like an old home painted up.
A new home builder has to provide a structural warranty for at least six years. However, many builders provide a 10-year or longer warranty. More importantly, the building is "up-to-code" meaning that it's built to the latest building regulations and has to pass all the building inspections.
Also everything in the house is new. New kitchen, bathrooms, roof, walls, ceilings, floors, windows, doors, plumbing, electrical, paint and appliances.
As the cost of residential land has dramatically increased in price, building a new home may not be economically and financially viable. And the high cost of renovations, which may not increase the value of an existing home, do not appear to be logical option.
There is one increasing trend in the market that makes economic and financial sense.
Knock down several houses and re-subdivide the land into smaller lots.
Older homes that are now outdated and in need of substantial renovation were built on large lots close to the city. If you have an old home on land large enough to subdivide into two lots that's an easy and profitable option.
If a developer can acquire two or more homes together on adjacent lots the homes can be demolished and the land re-subdivided into smaller lots for new homes. Depending on zoning regulations, the land may be suitable for high density apartment style construction.
However, land is now so expensive in the suburbs that homes only thirty years old are being demolished and the land re-subdivided.
Let's have a look at a real-world example.
I currently live in a house built in the early 2000s on a lot with a 20-metre frontage. My two adjoining neighbours also have lots with 20 m frontages. The 3 lots of land have a total street frontage of 60m.
The three homes are currently valued at $600,000, $650,000 and $700,000 giving a total value of $1.95 million.
We could demolish our homes and re-subdivide the land into 5 lots with 12m frontages suitable for narrow lot two-storey homes.
The 5 lots of land would be valued at $420,000 to $450,000 each with a total value of $2.1 to $2.25 million.
Our homes are just under 20 years old but there would be little sense in trying to renovate or extend the homes to add value. We can have the 3 homes demolished, sell the land and walk away with more money than trying to sell them as homes. We could keep three lots for ourselves and sell the remaining lots to fund building new homes.
It would be crazy to spend any large amount of money on renovation.
The value of the land component of a residential property has increased to the point where the majority of a property's value is the land. So spending money on improving or renovating the building may yield a poor return on investment.
Knocking down an existing home and rebuilding is a more economically viable option.
Building a new home has a lot of advantages over renovation. A new home is built to the standard of the latest building regulations and everything is new. The new construction comes with a statutory builder's structural warranty and certified building inspections.
Another option is the re-subdivision of existing house lots. This has become economically feasible in the suburbs of our cities. If you have an old home on land large enough to subdivide into two lots that's an easy and profitable option. Otherwise, you would need to approach your neighbours and make a proposal for property re-development.
A final option is to approach your neighbours and make a proposal to sell your properties together to a property development company for the purpose of high-density residential construction, such as, apartments or townhouses. The developer would demolish the homes and amalgamate the land together into a larger development. Normally, a developer will pay a premium price for each home if they acquire all the properties together. Most neighbours would take an interest in an opportunity to sell their homes for a significantly higher than market price and without paying real estate agent fees.