As an ex-appraiser I get the question a lot – if I remodel my (fill in the blank) will I make money on it?
There are lots of articles out there on this subject, which purport to tell you what the best investment is that you can make in your home.
If you’ve been reading my articles for a while, you know what my opinion is. It depends…
The recent recovery in the real estate market has a lot of folks thinking their next move. Should we move up? Remodel? Move out of the area? Now that you have equity in your home that you didn’t before, more possibilities open up.
I’d like to take a look at a number of common projects and get into specifics as to whether it might be a good idea in your case. This will be a series of articles, so I want to start off with a question that is really the unasked question at the heart of the question about whether it will pay off or not.
The formula to determine if an improvement is profitable is simple. Simply answer two questions: “What will it cost?” and “What will it add to the value of my home?” The first question is relatively easy – decide on a design, get three bids that are all relatively close to each other, and there you go.
The second question is harder, and is the subject of this article – the first in the series. I’d like to start where I think you should start – with thinking critically about the question.
If you have taken a college-level course in economics, you know that the value (measured as price) of anything in a free market is a function of supply and demand. Supply tends to react to demand, and if you are asking this question you are thinking about entering the supply side of this equation – you are going to improve your property and (potentially) offer it for sale. So what we are really analyzing is demand.
Demand for any product (like, say, a remodeled kitchen) it turns out, is comprised of two components: desire, and ability to pay. In other words, the more that buyers desire a thing, the greater the demand for that thing is and the more they will pay for it if they have the ability to do so. Conversely, the more money buyers have available to pay for a thing, the greater the price they will pay for it if they desire it.
This is a very important concept, and is the foundation for value: demand is a function of how much a typical buyer in the market wants the thing, and can pay for it.
This sounds so simple it’s obvious, and yet few people think it through. But if you start with this in mind, you can answer the question “If I improve my house with (fill in the blank) will I get my money back?” You actually know the answer intuitively.
Let’s look at a couple of examples.
How much value does a pool add to a home? You know intuitively a couple of things. 1) In a luxury-class neighborhood it will add more value than in a blue-collar tract neighborhood. 2) In a warm climate it will add more value than in a cold climate. These would be obvious generalizations, and true.
I have met many appraisers who insist that a pool adds, say $20,000 to the value of the home. Now that you’ve thought about it, you know that’s nonsense.
In a luxury-class neighborhood in southern California it could add a great deal more than that as the typical buyer would both desire the pool and could afford it. Demand would be strong, so the price would be driven higher.
In a neighborhood of lower-rent homes in Daly City, however, a pool could actually be a liability. It could detract from value. How can this be? Well, it’s cold in Daly City. The likelihood that the occupant would use it is slim. If the neighborhood is primarily rentals most tenants in this example would neither want the pool nor have the ability to pay extra for it. The pool becomes a maintenance headache and a liability. It could actually detract from value.
Another common improvement is a kitchen remodel. Many articles contend that this is one improvement that is sure to yield the greatest return. Again, I would say – it depends.
Here I think the desire component has more impact than the ability to pay (although both are significant.) What I mean is that the desire for an upgraded kitchen in a market is relative to the functionality of the kitchens in competing homes for sale. Here’s what I mean:
I remodeled my kitchen a few years ago. My home was built in 1928, and the original kitchen had total linear counter space of just over 10 feet. The stove and fridge were free-standing and away from the counters. There were a total of two above-counter cupboards, and three below-counter cupboards. There was one non-grounded socket near the counter, and one grounded socket near the stove.
It was cute, mind you, but not functional. It was typical of the homes in the neighborhood, but obviously a new kitchen with more modern setup would be desirable. In other words, I was confident that the typical buyer in my market would strongly desire a remodeled, modern kitchen more than the original. The ability to pay much might be a question, but the desire was not.
I was able to justify a total remodel, ripping the kitchen out to the studs, removing a wall, and building a new kitchen from scratch. The results were terrific. I probably overspent, but I will also probably get my money back.
On the other hand, I had two clients with homes built in the early 1970s, with very well-designed kitchens. The cabinets were older, but well-made and functional. Counters in both cases were built with large tiles from the 1970s, with older built-in electric ranges and ovens. Both had windows over the sinks looking out to the back yard.
One wanted to do what I did – rip out the kitchen and have everything brand new. The other decided to take a more conservative route. He left the cabinets in place, but had them stripped and stained, had new granite counters installed, put in a garden window over the sink with a new faucet. The money he saved on not replacing the cabinets he spent on upgraded appliances.
The bottom line is that client A spent more than twice as much and got very little extra for the investment. Her competition – other homes in the neighborhood with original kitchens – had kitchens that were older, but perfectly functional. Buyers did not see the difference between the original kitchen and the remodeled one as being that large.
The client who moderated his spending, however, got all of his money back in value. The difference between my situation and these two clients is that my kitchen desperately needed to be remodeled, while theirs were older, but functional. The desire of the typical buyer in each case would be different, and the remodeling plan would be best if it took that into consideration.
Over the next few months I’ll be looking at various improvements that you can do and asking the question: “Does this make financial sense?”
Does this topic interest you? Do you have a specific project in mind you would like to examine? If so, write to me and if it makes sense we can make it the topic of a future article.
My name is Casey Fleming, and I am a mortgage advisor in Silicon Valley. I originate mortgage loans throughout California.
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