What is over capitalisation and should it be avoided?

Written by Money Empire

February 18, 2019

Owning your own property is a heady sensation. It’s easy to look around your new home or investment and imagine all that you can do with it – from adding an extra room, to installing a spa pool outside to enjoy on those chilly evenings.

However, when considering all the renovations you might do it’s important to consider over capitalisation.

Understanding what over capitalisation means

Have you ever driven down a road only to spot a house that sticks out like a sore thumb? In comparison to the neighbouring properties, this one looks like it’s been transported from another, much fancier, suburb, possibly by the tornado that carried Dorothy’s house from Kansas.

More than just having the nicest home on the street, over capitalisation is when you invest more funds into the property than you’ll gain back in future earnings with resale. Renovations are a great way to increase your property’s worth, but the more you do the more your return on investment generally diminishes.

Should you avoid over capitalisation?

The easy answer is yes. Consider it this way – most people wouldn’t buy the house mentioned above. They’d rather purchase something in a location where the other properties are of a similar value. This means that the house could sit on the market for a long period, or sell below its actual worth – neither option is good financially.

However, in rare cases you might find that though the renovations may not get you the returns in a resale, they’re still worthwhile. For example, if you’re intending to live in the property long-term you’re not investing for financial rewards as much as personal benefit. Another scenario is knowing whether time is likely to improve the quality of your neighbourhood. In the short-term you might be over capatilising, but you’re setting yourself up for future earnings.

It’s relatively simple to avoid over capitalisation. Before putting funds towards improving fixtures and fittings, look at the suburb’s median house price. Compare it with your property’s current value. Raising it too far above the median is likely to result in over capitalisation. This comparison is useful for another reason as well – you might discover that you’re under capitalised. If the value of your property is well under the median you might find that it’s a good financial idea to invest money into renovations.

If you’d like to know more about growing your financial empire and how to gain the most out of your property, talk to the team at Money Empire today.

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