Overcapitalization: Why is cost not equal to value?

If you are unfamiliar with real estate terminology, you may be wondering what overcapitalization is. Basically, overcapitalization refers to overspending on construction or renovation costs, which means that the real cost of a property construction / renovation is higher than its true market value. Overcapitalization is also considered asset inflation. Confused? Let’s keep it simple. For example, Mr. A is planning to renovate his house by remodeling the bathrooms, basement, and kitchen; improvement of the living room and bedrooms; adding a porch and pool; Installation of vinyl siding, front entry fencing and garden extension. Mr. A decides to use high-quality and expensive materials in the renovation. In doing so, you forgot to consider the true market value and quality of the homes in this area, which was less than the value of your upgraded home. This is overcapitalization.

Now, the next question is what should be done to avoid overcapitalization? Simple! When home renovators and home builders plan home improvements, they need to consider a few factors that have the greatest impact on the overall property value. For example, assessing the neighborhood’s housing style, neighborhood demographics, urban landscape, neighboring property design trends, and recent resale prices of homes in the area.

Although improvements and renovations generally add value to a property, it would be a mistake to say that they will ALWAYS increase its value. The reason is that if the renovations and improvements are over the top, without taking into account the true value of the area where your property is located, you may be overcapitalizing your property. This means that the cost of your property will not equal its market value.

Therefore, it is rational for a home renovator or builder to be aware of overcapitalization and increase property value only to the extent that they can cope. Remember, you need to be very careful about overcapitalization when upgrading or renovating your property.

Often times, overcapiness occurs when people are not rational and do not have an entrepreneurial mindset in their approach. Typically, homeowners will spend more on fixtures and fittings with the goal of living in the property.

Some cultures often prefer to live in larger houses as a status symbol and will choose to spend more on improvements than is the norm for location.

However, if you are an investor or a builder, it is important to make the right combination as this will result in higher profit margins. Getting it wrong can often mean longer sales periods and discounted prices. Do your due diligence to avoid disappointment.