Harry Nicolaides, CEO, Century 21 South Africa fields the most frequently asked questions by home owners who are considering extending, renovating, remodelling or improving their properties.
Q: What is meant by the term over-capitalisation?
In property ownership terms, “over-capitalisation” means that if the cost of a property, defined as the initial purchase price paid together with any subsequent costs for upgrades (if any), total more than the selling price, the probable selling price or market price value of the property at any point in time and which, therefore, would result in a financial loss to the seller.
Simply put, the owner has paid more for the property and its upgrades than for what the property is worth at any point in time.
Q: Does this mean that when it comes to the time to sell, you cannot expect to recover the costs spent on upgrades, even though it enhances the property?
Yes, however, one must consider the initial purchase price of the property as well and not only the spend on upgrades e.g. A property purchased for R1-million 10 years ago may be worth R2,0-million now so even if the owner spends an additional R500k on upgrades today, they would still not have overcapitalised as their total spend is R1,5-million but the value of the property is R2-million.
On the other hand, no matter what actual or perceived enhancements are done by the property owner, if the probable selling price of the property at any point in time is less than what the owner invested on it, the owner would have over-capitalised on the property.
Q: When doing renovations, what should an owner consider in terms of the future value of the property?
The safest “formula” for an owner to use when considering doing renovations on a property without over capitalising is to determine what the comparative market price analysis (the CMA) of properties in the upper price range in the suburb is at that point in time. If the initial cost of the property plus any renovations totals less than the average upper range price, it would then be financially safe to undertake the renovations as the owner would not be overcapitalising, but again only at that point in time.
Q: Is it ever a good idea to overcapitalise?
It is never a good idea to overcapitalise, however, in very rare instances, it may be a calculated risk for a homeowner to overcapitalise temporarily or for a very short period in time. This is a rare occurrence and generally occurs in new developments or newly created suburbs or property nodes.
Occasionally, the homeowner has quantifiable and verifiable facts and information that the particular suburb or particular development will imminently become high in demand due to some other factors and which, therefore, will probably cause property prices to increase in the timeframe suggested by the research.
If these facts and the timing align, the homeowner will enjoy capital growth as the demand for properties increases in the area. This is especially true in new property nodes or new developments or established property nodes that will be positively impacted by other external property factors in the area (development of new retail centres, new schools, new green areas etc nearby).
Q: What are the benefits, if any?
There are no benefits to overcapitalising except in the rare occurrence discussed above – in the above instance it would be the proverb - “the early bird catches the worm.”
Q: Extensive and expensive upgrades and their effect on neighbouring properties? Do these encourage others to upgrade similarly?
Upgrades most certainly encourage neighbours to also do upgrades to some extent or another. Naturally, property owners desire that their neighbourhoods are upgraded and do evolve which then lead to an increase in demand for the properties and therefore, an increase in probable average selling prices for the neighbourhood. This results in capital growth for the homeowners.
Q: What are the most frequent remodels that, generally, are considered to be overcapitalisation projects?
They will be mainly areas that do not change the physical appearance or appeal of a property externally and also, which do not add to the total living area of the property. These will include the upgrading of kitchens and bathrooms. It must be noted, however, that upgrades and re-modelling do generally add value to a property; however, the cost of the upgrade must be carefully considered as described previously.
Q: Your top tip?
It is always important that a homeowner appoints a registered and qualified estate agent who has access to the latest technologies, systems, and databases, and has “live” data in order to verify a property’s CMA and importantly, to determine future market trends of any particular development, suburb or even city.
