Filed Under: Personal Finance, Real Estate
Think Before You BuildThe return on investment (ROI) of any given renovation project is a function of local market characteristics, the condition of the residential real estate market when the property is sold and the quality of the work performed. Historically and on average, certain projects, such as the addition of a wood deck, kitchen and bathroom upgrades and window replacement, have shown the greatest ROI regardless of the property's location or the state of the residential property market.
However, unless the remodeling project is designed to fix a structural issue or design flaw, it is unlikely that a homeowner will earn back more than the cost of construction. If cost recovery is as important a consideration as increased enjoyment from enhancing the property, then homeowners should consider the tastes of prospective purchasers when deciding which projects to pursue. (Find out which home improvements will boost your bottom line come selling time in Fix It And Flip It: The Value Of Remodeling.)
For investors remodeling rental property, the cost of enhancing a property can be recovered not only through sale, but also through the increased rental rates commanded by updated residences. (Owning property isn't simple, but there are plenty of perks. Learn more by reading Investing In Real Estate.)
Homeowners, however, need to be careful of which projects they choose to complete, since the potential value gains can only be realized to the extent that there are buyers willing to pay for the renovations.
Consider Your LocationWhen considering any type of project, it is essential to make sure that any improvements made are appropriate for the particular type of dwelling and local property area. One mistake homeowners often make is improving their homes well above the average of neighboring houses. Buyers are attracted to particular neighborhoods because of the services located nearby and because houses in that area are trading in that buyer's price range. Although a house improved well above others nearby may still receive the same or more interest than others being marketed, it is unlikely that it will command a premium well above average because of the extra improvements.
Real estate agents will tell you that when depressed real estate markets rebound, percentage value increases are higher for the average- or below-average-priced homes in a given neighborhood and lower for houses priced at the top of their respective markets. It is during these periods of increased economic activity and increased real estate demand that improvements will have the greatest impact on a home's market value. (Read How Interest Rates Affect Property Values to learn more about this driving force behind house prices.)
Time also will have an impact on the ability of an improvement to increase property values. Structural or design improvements, such as building additions or finishing raw space, will add value for much longer than projects like updates to kitchens and bathrooms or technological improvements, such as new air conditioning systems, because these risk becoming obsolete over time.
Geographic location will also have a great impact on which projects will have the quickest or greatest payback. For instance, the maintenance time and cost of in-ground swimming pools make it difficult to recover the cost of installation and in some cases will reduce the overall value of a home. However, this may not be the case in the southeast and southwest U.S., where extended periods of very hot weather make swimming pools a valuable addition for some homeowners. (Choosing the right location can lead to big profits - read more in Profit With Real Estate Land Speculation.)
Government IncentivesBecause of the deductibility of mortgage interest from income taxes, Uncle Sam may help to subsidize home improvement, making the cost of construction even less burdensome for property owners. (Learn how to take advantage of this credit in The Mortgage Interest Tax Deduction.)
For the less risk-averse, property owners that have accumulated adequate equity in their homes can use financial instruments, such as a cash-out refinance or home-equity loan to finance their construction projects. Using these methods, the only cash necessary to complete the contemplated projects would be the interest payments to maintain the loans, which in most cases are tax deductible. The principal will be repaid when the property is finally sold. (Is a home-equity loan a good idea? Find out in The Home-Equity Loan: What It Is And How It Works.)
Project Returns on InvestmentThe ultimate reason to take on any home remodeling project as an owner-occupant is the enjoyment received from living in an updated home. For those hoping to profit from a remodel as well, there are several sources that will give some insight into expected payback for particular projects. For example, REALTOR® magazine publishes an annual "Cost vs. Value" report that compares the cost of common remodeling projects and shows the payback that homeowners can expect. These payback estimates are based on the residential real estate market fundamentals at the time and the average cost of construction.
Table 1 are national average estimates, but homeowners can find more specific information at Remodeling Online that will provide the same estimates for different geographic areas of the U.S. These average payback ranges for the most common remodeling projects give prospective sellers a broad indication of which projects have the greatest probability of returning a bulk of the project cost at sale. Differentials in average recoveries are explained by the scope and quality of work performed, with smaller, less-useful projects being on the lower end of the range.
| Table 1 |
| Project | Avg. Recovery % |
| Wood Deck Addition | 80-85% |
| Siding Replacement | 75-83% |
| Minor Kitchen Remodel | 75-83% |
| Window Replacement | 75-80% |
| Bathroom Remodel | 70-78% |
| Major Kitchen Remodel | 70-78% |
| Attic Bedroom Remodel | 65-76% |
| Basement Remodel | 65-75% |
| Two-Storey Addition | 65-74% |
| Garage Addition | 60-70% |
Improvements, such as office and bedroom remodeling had the largest recovery ranges: from 50-70%. The large spread is due to differences in the size of the renovations and the importance the room has on the overall design of the home, such as guest bedroom versus master suite. (Interested in remodeling a flip? See Top 5 Must-Haves For Flipping Houses.)
ConclusionWhen contemplating any remodeling project, homeowners should consider the value they will receive from the project over any cost recovery that may be available from sale. However, when contemplating two equally useful changes, homeowners should research local real estate guides to determine which projects are most likely to pay for themselves. Remember that bigger is not always better, and spending more does not always ensure a greater amount of value creation. Home prices will always reflect the tastes of local property buyers and the amounts that buyers are willing to pay in a particular neighborhood or subdivision.
by Robert Stammers,CFA
Filed Under: Personal Finance, Real Estate
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