Most people remodel their home to make it better fit their needs and desires. They upgrade the kitchen, build a deck, or add a bathroom to make day-to-day living more practical and enjoyable.
But remodeling can also play a role in financial planning. The home is typically one of our biggest investments. While much of its value is controlled by location and the general economy (things we can’t easily change), some portion of our home’s value is determined by its condition, size and the degree to which its layout and decor are up-to-date.
From a straight financial standpoint, it makes sense to maintain the home well. Taking care of small problems while they are still small can eliminate the need for most larger expensive repairs. Problems that are ignored tend to foster additional problems. For example, a simple thing like clogged gutters can lead to wet basement problems and even pest infestations.
Remodeling as an Investment
But what about big expenditures like remodeling a kitchen or creating a master bedroom suite? Clearly such improvements can have a very positive effect on lifestyle and comfort, but how do they fare as investments?
A number of national magazines publish detailed guides to the return on investment of various kinds of remodeling and home improvement projects. Typically, they say something like the average bathroom remodel costs $4356 and adds about $5150 to the resale value of the home. That’s an 18.2 percent return in a few weeks. Not a bad investment, if only you could count on it being true.
Unfortunately, while such articles make good reading and promote remodeling (something very popular with advertisers who sell home-improvement products), they often reflect a theoretical set of circumstances that often fail to manifests themselves in the real world. Consequently, you have to take the article numbers with a large grain of salt.
From a strictly financial point of view, large remodeling projects don’t often deliver an immediate positive return on investment. However, there are some circumstances where gains are likely.
Generally, good rates of return are most likely in circumstances where the home is catching up with other homes in the neighborhood. If the house is among the lowest priced homes in the neighborhood, then a large investment may garner significant returns.
Consider Your Neighborhood
This is most likely to happen in a close-in, older neighborhood where the original houses were quite small. Over the years, as the value of the underlying land has risen, many of the homes have been added on to and remodeled extensively. Eventually, most of the homes have been upgraded. Remodeling and enlarging the home to meet the new standard is usually a great investment.
Similarly, large scale remodeling in an urban neighborhood that is rebounding can be a wise move. Sometimes run-down homes are available at a very low cost. Some people make a career/hobby of buying such homes, gutting them, remodeling them, and reselling them for substantial returns.
If you home is in a neighborhood full of homes with four bedrooms and two baths and your home only has one bath, investing in a second bath is a good idea: Even a third bath might earn a good return. But adding a fourth bath in such a neighborhood is likely to add very little to the value of the house.
A better overall way to look at the financial returns of remodeling is to look at what you’re getting for your net costs. For example, consider a major kitchen remodeling project that costs $40,000, but that actually adds $30,000 to the value of the home. In essence you are getting your fancy new kitchen for net costs of only $10,000. The question to ask yourself is “Does the new kitchen add enough enjoyment and practicality to my family’s daily living to justify net costs of $10,000?” If the answer is yes, start remodeling!
Sometimes a fire or major repair requires you to redo part of the home. In that case you might be comparing the pros and cons of just replacing what was there with substantially upgrading the spaces to meet modern standards of looks and function.
Simply replacing what was there, might restore the value that was lost, but is unlikely to add new value to the home. On the other hand, a major upgrade will almost certainly add new value. To make the decision, take the net costs of the upgrade and deduct the costs of the simple replacement (the minimum costs you know you have to incur.) You can also deduct any insurance money that may be involved. When you add it all up, it almost always makes sense to go with an upgrade.
Real Estate Agents
In order to make good decisions in these matters, it is important to use real numbers about the extent to which various projects might add to resale value. Fortunately, every neighborhood has one or more experts who will happily share their advice for free. Who is this local benefactor? Your local real estate agent.
Choose an agent that specializes in a particular neighborhood and has years of experience. These agents spend their days talking to buyers and seeing their reactions to various houses and the improvements that have been made to them. They have watched people go through the decision making process that determines the offer price. These agents have the information you want.
Best of all, most real estate agents seek opportunities to strengthen relationships with potential clients like yourself. For them, talking about the projects you envision and the likely financial outcomes, is a good way to show you how knowledgeable they are in their field.
With the help of an experienced local real estate agent, you can make sound decisions about remodeling as an investment. Unlike stocks and bonds, this is one investment that you and your family get to enjoy every day!