One of the great things about being a home owner is that you can spend all kinds of cash on your house and then pretend you are making money on your “investment”. The way to accomplish this, is to complete a renovation, and then assume that the value of your house has increased by at least the amount of the renovation.
Let’s look at an example:
Mike’s neighbour: Hey Mike, I love your new patio stone walkway. How much did it set you back?
Mike: I paid $2,500 to get it done, but I reckon it added $18,000 to the value of my house. Needless to say, it was a great investment.
Mike’s neighbour: Wow, you’re a financial genius.
Mike: Thanks.
Ok, this example was a bit exaggerated, but it is certainly true that spending money is easier if you think you will be getting a rebate. Even if that rebate is in the form of an increased house value.
The reality is that most renovations or fixes to a house will add some amount to the house value which could be more or less than the value of the renovation itself. The problem is trying to determine how much.
Why should I care about this?
You don’t have to worry about the return on investment of every dollar you put in your house. There is nothing wrong with modifying your house to suit your own needs, even if it doesn’t add to the value. However, if you are planning to sell the house anytime in the near future, it doesn’t hurt to consider the relative merits of different renovations you are considering.
Using a calculator to determine renovation value
There are numerous “calculators” available on the net such as this one which supposedly help you determine how much of your cost will add to the value of the house. I don’t think these “calculators” are very useful.
For one thing, that particular calculator assigns a percentage range. For bathrooms, it gives you a value increase of 75% to 100% of the renovation value – regardless of how much you spend. So if I spend $10,000 on a new bathroom, then my return is $7500 to $10,000. If I somehow spend $100,000, then my return is $75,000 to $100,000 which doesn’t make sense for most houses since a $100,000 bathroom would be a waste of money.
These “calculators” also ignore the value of the existing bathroom and a whole host of other factors. The only use I can see for this calculator is that it can help determine the relative value of various renovations. For example: it values bathroom renovations (75%-100% recoup) much higher than landscaping (25%-50%) which in general, I agree with.
How to determine the value of a house renovation
Unfortunately, I don’t have an easy formula for this, but I do have a few ideas about what to consider when trying to determine the value of a house renovation.
Age of renovation
If the renovation is brand new, then in theory, the buyer should be willing to pay the full price of the renovation, if it’s something they would have done anyway. For example: if a new fence (where there was none before) cost $2,000, then the value of the house should increase by $2,000.
What was there before?
If you remove something that has value, then you should subtract that amount from the transaction. For example: if you remove laminate counters in good condition from your kitchen (value $600) and install new granite tops (value = $2,000) then right off the bat, the value added will be a maximum of $1,400 assuming the buyer will pay $2,000 for the new counters.
Will the buyers appreciate the entire renovation?
Buyers don’t necessarily appreciate the cost and hassle of a renovation. This especially applies to renovations that involve a lot of “invisible” work, such as insulation, wiring etc. For example: you spend $50,000 on a new kitchen. A buyer might love it, but only attach a value of $30,000 to the kitchen, because that’s what they think it would cost them to build it.
Different folks, different strokes
Not everybody values the same things in a house. This is a big one and I think it is the reason why outside renovations tend to have a lower return on investment, compared to inside renovations. As I said in #1 – if you add something to a house (ie new kitchen), and a buyer would have done that exact same renovation, and they know the cost of that renovation, then I think they will give the proper value (ie the cost of the renovation if it is recent). The problem of course is that if a buyer isn’t crazy about the new kitchen or doesn’t want to pay for the extreme costs of a high end kitchen, then they won’t. This is why more modest renovations tend to hold their value better then over the top renovations.
Another example that I’ve seen in several houses is where an owner take a three bedroom + small bathroom house and converts one of the bedrooms and the small bathroom into a huge bathroom. This is a pretty expensive renovation since most of the examples I’ve seen end up with huge bathrooms that look like they belong on a magazine cover. The problem is that you now have two bedrooms instead of three. I believe that for most people, this new layout is worth less than the old layout of three bedrooms plus a small bathroom.
Even if you assume there is no loss in value, you’ve lost the expense of the considerable renovation. In my mind, removing a bedroom to expand a bathroom is a very poor investment.
Unusual or excessive renovations means lost value
A lot of inside renovations are fairly standard. An updated kitchen, bathrooms, nice floors, decent walls, ceilings, windows, lights are things that most reasonable buyers also want and will (hopefully) value appropriately. The key is to keep it reasonable. Nice new hardwood floors at $10/sq ft are likely a good investment. Buying imported teak boards with real elephant tusk inlays at $100/sq ft might sound impressive, but most buyers will still value that flooring at the normal going rate for hardwood.
Usage is important
Outside renovations are a lot more variable. A fence (where there wasn’t one before) is somewhat standard, so perhaps most buyers will pay for that. Decks are pretty standard and probably add a fair bit of value, within reason. Things like extra patios/gardens etc are very subjective – some people will love them, some will remove them after buying the house.
A pool is a great example – some people love them, others hate them.
The usage of the yard is key. When I was single, I had mostly gardens in my small backyard and not a lot of open grassy space. Now that I have two little kids (and no time to garden), I much prefer to have less gardens and more open space for soccer games.
Another example: my neighbours have a back yard which is beautifully landscaped. The deck is old, but the main back yard had all kinds of nice flagstone patio stones and gardens etc. The only problem is that they have two little kids and they are envious of our plain grass/weed yard because it’s a much better play area for the kids. They’ve removed quite a few of the stones.
Average price in neighbourhood
Another theory I read about has to do with the price of your house compared to the neighbourhood. If your house is worth more than the average house in your area, then the return on investment for renovations will be lower than if your house is worth less than the average. This effect gets larger, the more your house price deviates from the average.
This makes sense to me – for most areas, people aren’t usually willing to pay a lot more for a nicer house – they would rather buy a regular house in a better area.
Conclusion
For any renovations you should consider: The value of what you are removing.
- The value of what you are removing.
- How standard is the reno you are doing? Is it something a new owner would want to do themselves? Would they spend the same amount of money you did?
- How long will you stay in the house? If you are planning to move within a few years, then it’s wise to consider the added value of every renovation.
What do you think? Do you worry about the return on investment for home renovations?