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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

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Value: What’s your project worth?

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A concept that is both prevalent and relevant, especially due to the current economic conditions, is the idea of value. The concept of value is applicable to how we spend our money, and the perceived worth of what we receive in return. It is especially important when it comes time to decide on whether to pursue a design project. Design is very subjective, so it makes it quite difficult to determine the value of a design project. Even if a project is deemed necessary and makes good economic sense, how does one make a value judgement concerning the most detailed decisions? Something as (seemingly) insignificant as choosing between a fluorescent light bulb and an LED bulb can all be traced back to the initial value proposition: is this product, service, event, decision, etc. valuable?

We all want to get the most bang for our buck, and stretch our money as far as it will go. Recently, Todd Vendituoli wrote a post concerning the way houses have often been treated solely as financial assets instead of homes for nurturing our lives. This often leads to an over-simplification of how we evaluate a design project’s value. In order to properly analyze a decision to build, remodel, hire a designer or spend the extra money for granite instead of laminate, one must fully understand the concept of value.

Value has many facets, but two important concepts are Return on Investment (ROI) and Utility. To explain these concepts, I’ve asked my husband, David, to detail them in layman’s terms. David received his bachelors degrees in economics and finance and his masters of science in finance. He currently works as a portfolio manager assistant. I thought he’d be better qualified than me to explain these concepts.

Return on Investment (ROI) is a simple concept that can be used to gauge an investment.  If I was to spend $20,000 renovating my kitchen, and an appraiser valued the work at $40,000, my ROI would be 100%.  This is pretty simple; however, concepts begin to get muddy when you introduce “utility”.  At the risk of oversimplifying, utility is economic jargon for the value of happiness.  ROI fails to capture this aspect of economic value that can be critical when it comes to something as personal and every day as your home.

Let us analyze two situations.  In both of these scenarios you will be renovating your home.  The goal is to realize some ROI on the eventual sale of your house.  The operative word is “eventual” since you will be living with these updates for some time.  For these renovations, let us say that you will spend $20,000.  Scenario A, your goal is to maximize your ROI at 100% ($40,000 of end value).  To do this, you’ll need to create the most appealing renovation to the general populous: granite counters, builder beige walls, white trim, hardwood floors, etc.  Scenario B, your goal is to balance ROI and your tastes with ROI at 80% ($36,000 of end value): Quartz countertops, plush carpets, modern finishes.  At first glance, one may choose Scenario A.  But, we have failed to capture the utility generated by the renovations from the homeowner’s perspective, i.e. the enjoyment you will get out of selecting finishes you love compared to finishes you ‘settle for’ for the sake of broad resale appeal. Let us say that scenario A creates utility equivalent of $5,000, while scenario B – which better suites your tastes – generates $15,000 in utility. Essentially, scenario B makes you three times happier than scenario A.  At this point, it makes more sense economically to go with the personalized renovation using finishes you love. It creates a total value of $51,000 (Compared to the $45,000 alternative).  Value is still being generated, even though it isn’t money in your pocket.

These concepts may seem intuitive and even overly simplistic.  It makes sense that one would want to be happy with a renovation that they must live in.  However, it’s far too easy to bypass the value of one’s enjoyment since it’s not “hard cash”.  You must ask yourself though, what’s the point of the hard cash?  Most likely, the end goal is to spend it on something that makes you happy (vacations, dream home, philanthropy).  Few people have the goal to die with a lot of cash and never spend it.  By maximizing our utility AND ROI, we maximize our utility and overall quality of life.

Now that we see the difference between ROI and Utility, we can read between the lines and understand that everyone simply wants value added to their projects. Whether they are building an office tower, designing a master-planned community, or remodeling an outdated kitchen, everyone wants their project to have value – from the overall form to the last nut and bolt. There are many ways to add value to a project that may not always be apparent.

Hire a Design Professional
Hiring an architect or residential designer can add value to your home in multiple ways. Not only are architects trained to evaluate multiple value propositions simultaneously throughout the design process, but the end result can be appraised at a higher dollar amount and often sell faster than comparable structures. In addition to monetary gain and a shorter sales timeline, a custom designed home will bring a higher utility since it will be exactly what you need and want. Imagine that all of the frustrating aspects of your current home were adjusted to your tastes – isn’t that something that is valuable? Hiring a design professional adds many facets of value to your project. To find out how to choose the right designer, read this recent article.

Add a Unique Feature
Another way to add value is by incorporating a unique feature in a standard design. Green features and systems, special design elements, unusual finishes, or amazing vistas can all add value to a project. All homes will have the basics: gathering space, cooking and eating space, and sleeping space; however, adding unique spaces to a home through renovation can be a way to add value. Spaces like sun rooms, landscaped outdoor areas, or flexible multi-purpose spaces can be the feature that sets your home apart from the rest. Whatever you add, be sure that it is appropriate and that it maintains the integrity of the overall design.

Strive for Quality
By using only the best materials, products, and professionals for your job, you can ensure a higher value for your project. Everyone knows cheap materials won’t bring a premium when it comes time to sell, and may even cost more money in the long run due to maintenance or poor installation issues. It is always important to balance high quality with monetary cost while being mindful of whether the selections contribute to the project’s integrity. For example, while hardwood floors may be a premium product, adding them to a renovation in a neighborhood where linoleum and carpet are more common could result in less value added than if an engineered or laminate floor was selected.

Create Multi-Purpose Spaces
Another way to create value in a project is to designate multiple activities for a single space. By adding an element of flexibility, you can create a wider market appeal. Think of it as diversifying an asset by exposing it to multiple purposes. If you provide a space that can double as both an office and guest room, future buyers will have options as to how they use the space. A dual functioning room can also save you future time, effort and money when your own needs and desires change. By allowing a design to serve multiple purposes, you are embedding flexibility into your future, and that can equate to savings. Another cost saving measure can be found by decorating with furnishings rather than semi-permanent finishes. Decorating your home with colorful paintings, textiles and objects is much easier and cheaper to change than floors, cabinets or walls. Avoiding costly renovations in the future definitely adds value to a project.

Remember that while any one of these suggestions can add value, they should not be considered in isolation. The best materials can be poorly installed, or used in an illogical design that detracts from a project’s value. It is always important to consider each of these elements and how they relate to one another. For this reason, your project will get the most value from hiring a design professional who will be able to recognize and address these factors from start to finish. Consider bringing on a design professional for consultation on your next project to see how they can add value to your design.

 

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Creating from Chaos: Turning your Design Project into Reality

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Most people who visit the Archability site and read the blog have at least one design project they would like to implement either now or in the future. The type of project may include a newly landscaped backyard with defined outdoor rooms. For some, it might be a kitchen or bathroom remodel project that includes simple updates or complete gutting. Others may have the desire to add another room or floor to an existing house. Still others may have dreams of designing and building a custom home on a new piece of property.

Whatever the design project may include, each one has a unique set of challenges and obstacles that must be addressed and overcome to see the project through to fruition. These challenges can often become overwhelming for an untrained layman, and may frustrate even the most determined homeowner to the point of giving up on the dream entirely. Whether a lack of vision prevents progress or unforeseen obstacles spring up during the course of implementation, a project is at risk of failure without the proper tools and team in place. To ensure your next project becomes a reality, enlist the assistance of a trained and educated design professional.

Often times when a project is intimidating, it is a sure sign that you’re in over your head. This is an indication to consult a trained design professional who can guide you through the details of your project. Whether the designer serves as an occasional advisor, or manages the project from start to finish, they can ease any insecurity you may have. A talented designer can view your project from a fresh perspective and provide educated solutions that are both creative and functional. Most designers are able to create a design response once thought impossible due to their expert knowledge and experience. These design professionals can find order within chaos and turn your lemons into lemonade:

Landscape architects are experts in creating inviting outdoor spaces. Through the proper use of scale, proportion and appropriate plant species selection, they can turn a patch of dirt into an oasis. If your backyard is looking bleak, sign on with a landscape architect and watch your dull dirt get transformed into your perfect paradise.

Interior Designers can refresh an outdated space and make it feel new with ease. They can reinvent and repurpose existing objects so that budgets are met and waste is done away with. If your home’s interiors are stuck in the last millennium, bring in an interior designer to give your home a make-over.

Architects, remodelers and building designers can evaluate current use patterns and habits and tweak them to improve efficiency of space. Even a small spatial change can translate into a huge impact on the way we live our lives. If you feel that your spaces just aren’t working well, sit down with one of these professionals to evaluate how some changes will improve functionality.

Architects and building designers can create a custom house design tailored to the way you live. By balancing current habits with needs and wishes, they can produce a creative and beautiful solution that meets both expectations and desires. If your dream is to build your own home, consult with an architect or residential designer to discuss how your dream can become a reality.

Professionals across all these disciplines view design problems and challenges as a framework for their solution. While it may appear to be a daunting task or impossible obstacle to the average person, a designer thrives on creating within limitations. Hiring a design professional to tackle your next project will open up a world of possibilities. Larger projects outside the scope of residential design may enlist the services of design professionals across multiple disciplines. For a guide on choosing the right design professional for your job, be sure to read our previous article detailing the process.

 

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