How much should I spend on renovations?

Recently, I became involved with a property that was clearly over price for the neighbourhood. It was a very well built side by side duplex, with each side having a self-contained suite. Workmanship and finishes were first class.

We see all kinds of programs on TV where, generally, new investors go into a property, with the hopes of renovating and making a killing when they resell. It would be interesting to learn what percentage of those "speculators" actually make money on the transformations. I call them speculators because newbies entering a business they do not know with the hopes of making a profit on the flips are not true investors, IMHO. They may become investors over time and with experience.

A rule of thumb in renovating a home is to never spend more that 5% of the value of the home on a renovation. So, if a home costs $300,000, the most you should spend is $15,000.

There is a lot to be said for adding rouge and lip stick only when renovating a home, in others, cosmetic repairs only. However, if the property in question is the lowest valued home in the neighbourhood, and doing major renoes, such as redoing kitchen and bathrooms, will bring the value up to the neighbourhood standard, then by all means do the renovations.

What about the property I mentioned above? Well, another rule of thumb is, "Never do improvements to a property that would increase its value more than 10% above the neighbourhood average." If homes in the area have an average value of $300,000, and the combined value of the property in question and the renovations totals more than $330,000, you will be over improving the property, and will never get your money back.

In this case, the market value of surrounding detached homes was about $330,000. The asking price for each unit was $400,000. I first looked at these two units in August 2008. As of June 2009, they are still for sale.

Years ago a friend of mine owned a home in an area where the average price was about $140,000, as I recall. He decided to do MAJOR renovations to the home. The house was a one of a kind home when finished. They had a huge walk in closet and bathroom off the Master Bedroom (taking out the other two BRs on the main floor in the process), a cavernous basement family room, a party room with hot tub accessed through the MBR by a circular staircase. This room had a spectacular view of Halifax Harbour. This is a house that I would love to own.

When my friend put it on the market, his asking price was well into the $200s, far above the 10% guideline. I do not know what it finally sold for, but I am pretty certain my friend took a bath, other than in his hot tub.

In summary, when doing renovations, keep your work under 5% of the value of the property. Do not take the supposed value of a property after renovations over 10% above the average value of the neighbourhood.