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Remodeling: Return on Investment

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Contrary to popular belief and perpetuated misnomers, your home is not an investment. Unless you own more than one, a house is a living expense, similar to groceries or clothing; it is a necessity. By nature, investments are not necessities. While there are many home owners who realize a gain on their home’s sale, it is not the outcome that should motivate a home purchase. Similarly, while remodeling your existing home could translate to an increased sales price or faster sale, it is not the type of investment that will provide large gains in typical circumstances. In fact, most home remodeling projects will lose money. Although remodeling projects won’t measure up to typical investments, there are benefits to remodeling a house and putting some money (or sweat equity) into your home. By understanding the basics of investing and how it relates to remodeling, you can make an informed and educated decision when faced with the choice to remodel.

First, one must understand the concept of Return on Investment, also known as ROI. Investopedia is a great resource that explains financial terminology, and it defines ROI as:

As an example, let’s say you own a $100,000 house. You decide to do a kitchen remodel that costs $10,000. When you go to sell your house, the appraiser says you can list your home at $108,000 given the recent improvements. Typically, home improvement TV shows as well as almost every major retailer of home improvement products mistakenly tells you that you’re getting an 80% ROI. This is incorrect, because using the ROI formula, the math actually turns out this way:

Gain from investment ($8,000) – Cost of Investment ($10,000)

Cost of Investment ($10,000)

=

-0.2 (or – 20%)

As you can see, negative twenty percent is not a great investment at all! If this were a return from your stock investments, you’d have sold long ago and had strong words with your financial adviser. What actually happens is that remodeling costs can be recouped, depending on the type of project and your current real estate market conditions. In some cases, you might see a return on your remodeling investment if your home is in a highly sought after area, or if the supply of available homes is low compared to the demand. Simply put, remodels make sense for these reasons: resale, happiness, and renting.

Resale

Historically, kitchen and bath remodels will bring you the most bang for your buck, allowing you to recoup approximately $0.75 +/- for each dollar you invest. The caveat to this is the scale of your kitchen and bath remodel. Smaller, basic upgrades recoup the most money, while all out renovations actually bring back less (by about 10%). This is due mainly to the fact that buyers expect a home to be in working order. If all the homes for sale in your area are in working order, the distinguishing factor between them becomes a matter of aesthetic taste. In this case, it would be best to consider a ‘face-lift’ remodel that would include basic touch ups, curb appeal and simple finish replacement where soiled or worn out. It would not be as prudent to invest lots of money in a complete re-do of the home, as buyers expect the home to be in working order, and costly remodels may not fit the buyer’s specific tastes – adding nothing to the value of the home in their minds. On the other hand, if your home has broken appliances, structural problems, a leaking roof or is in need of a severe overhaul due to neglect, a major remodel would be a better decision, so that your home will meet buyer expectations. Buyer’s may not love the color granite you chose but can live with it. They will not be impressed if the roof has a hole in it and may walk away all together. The other point to consider with resale remodel projects is liquidity. Liquidity refers to how easily an asset can be bought or sold. In this case, remodeling your home (even with small improvements) can help your home sell faster than competitor’s.

Happiness

In economic terms, happiness is referred to as utility. It is defined as the “total satisfaction received from consuming a good or service”. Remember that your house is a living expense, much like a product or service. It is easy to picture your ‘dream home’ that makes you smile just thinking about it. This is the easiest way to describe how utility works. If money were no object, most people would build their dream home and have every detail exactly as they want it. In reality, money is a resource that is scarce and we must make difficult decisions on the margin based on happiness. In terms of remodels, let’s say you’re living in an older home with a cramped kitchen that has little or no counter space. After years of putting up with it, you may decide that it is ‘worth it’ to you to spend some money to improve the layout, update the appliances and make it your ‘dream kitchen’. While you don’t have the money to remodel your entire home, the kitchen is important to you, and thus, would bring you the most enjoyment. When you consider whether to undertake a remodel, your personal happiness should be your top priority. Since most remodels only recoup a portion of the project costs, consider if your remodel will bring you enjoyment, satisfaction and make your daily life less stressful. Weigh the potential happiness against your current conditions. If you find the prospect of improving your home is enticing for multiple reasons, it is a good idea to pursue a remodel. After all, the best remodels are those that you get to enjoy – not just potential buyers!

Renting

Finally, another consideration for remodeling your home is whether you plan to rent it out and purchase another house. As property values begin to increase again, many people are considering the idea of owning an income property from which they can collect passive income. For income properties in need of some TLC, remodeling makes a lot of sense in markets where buyer expectations demand it. Not only will you gain a competitive edge compared to other rental units, but your rental could demand a higher monthly payment. In addition to monthly income, any improvements you make to a rental property can be depreciated over time. That means you can deduct the cost of the remodel from your taxes, divided over a period of time. For example, if you paid for a $10,000 remodel to your rental property, you could deduct $1,000 per year for 10 years from the property’s taxable income. This effectively reduces the overall cost of a remodel, potentially providing or increasing your return on investment.

While the TV shows misconstrue how much money you can gain from a remodeling project, there are still advantages to taking on a project even if you don’t get 80% ROI like they tout. Selling your home faster, finding personal enjoyment from a remodeled room or even writing off the cost of a project from your rental property’s taxes are all viable reasons to invest in a remodel. To ensure your project runs smoothly and impresses buyers, renters or you significant other, be sure to choose the right design professional and understand how you can add value to your home with their services.

Brinn Miracle is an architectural intern, journalist and residential designer. She writes about architecture and design topics at her blog, www.architangent.com/blog

1 Comment

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  1. France escort
    March 28, 2013 at 11:10 am #

    i love your blog its amazing

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