There was a recent article in the Globe & Mail where a real estate agent was interviewed about her opinion on holding open houses if you are selling a house.
To summarize, the agent thought that open houses were a waste of time with only nosy neighbours dropping in to check out your belongings.
I disagree. I think those are the words of a lazy (and quite possibly untrustworthy) real estate agent who doesn’t like doing open houses.
Benefits of having an open house
When I sold my first house, some prospective buyers who had scheduled appointments with their agents, also came on the weekend for the open house.
Why would they do this?
Less structured – They don’t need an appointment, so there is some flexibility as to the time and day when they check out the house.
No agent – No need for an agent, which makes things easier to schedule and allows the buyers more time to look at the house without using up their agent’s time.
Bring a friend/relative – Easy opportunity to get other opinions on the place.
Second look – If you are seriously interested in a house – why wouldn’t you want to have a 2nd or even 3rd look at it before signing your life away?
Is it just neighbours who go to open houses?
Neighbours can indeed be nosy, but they can also have friends who might be interested in moving to the area. It’s very possible that your eventual buyer will be a result of one of your streetmates who sees your house and tells someone about it.
The more people are at your open house, the more ‘buzz’ there is and the greater the chance that you will get an offer or have more bidders on your house. Neighbours will always be welcome at any open house I have.
Casual dropins
Do casual ‘window shoppers’ ever buy houses? I’m certain they do, because I almost did.
About 10 years ago, I got into the habit of looking at local open houses to get ideas on how to fix my house up. One rainy Saturday I checked out this one house and fell in love with it. It was large with a great third story party room (I was single and childless at the time) with a walkout deck. I thought it was fantastic.
Because I casually dropped in on that open house, I went from being a curious neighbour (I lived on the same street) to calling my agent, scheduling a visit and seriously considered making an offer. In the end I didn’t because it was a bit expensive for me and it needed some work which would cost even more.
Although I didn’t buy that house, I suspect there are other examples where someone attended open house for ‘fun’ and ended up buying the house.
Why not have an open house?
And really – What is the downside of an open house? Sure you have to clean up and vacate the place for a few hours, but you have to do that anyway for scheduled appointments.
Do you want to do everything you can to sell your place or not?
What do you think – Are open houses worthwhile if you are selling a house?
In Canada, if you buy a house and have less than a 20% down payment, you have to pay a CMHC (Canada Mortgage and Housing Corporation) fee to insure the mortgage. It should be the goal of all home buyers to have a larger down payment, but it’s not always possible.
One scenario is where someone has enough money to make a 20% down payment and is wondering if they should use all the money for the down payment or put down a smaller down payment and use the extra cash for other things. Another scenario is where a buyer is close to reaching 20% down payment and only has to borrow a small amount of money to reach 20%. Should they do it?
I can think of three examples where a person bought a house with a smaller down payment, even though they had enough money or means (via borrowing) to reach the 20% necessary in order to avoid the CMHC fee. One blogger shall remain nameless, the other person was me (12 years ago) and the third person is a blogger at Moneyville, which is owned by the Toronto Star. I’m going to use Madhavi (the Moneyville blogger) as my example, only because she is the most recent.
Madhavi and her family owned a condo, which they sold and bought a family house. They netted $115,000 from the condo sale and bought a house for $560,000. 20% of $560,000 is $112,000, which means she could have put down a 20% down payment and avoided the CMHC fee.
Instead she decided to use roughly half of the money to pay down debts ( a worthy use ) and only put down a 10% down payment.
The problem with only paying a 10% down payment is that you have to pay the CMHC fee. Does that mean she paid a big fee just to consolidate some unsecured debts?
She mentioned in the article that the CMHC fee was $12,000 including tax. Had she put down $115,000 down, the CMHC fee would have been zero since mortgages with a 20% down payment or higher do not require insurance.
By using a smaller down payment, Madhavi was able to reduce the interest rate on $59,000 of debt. If we’re going to analyze the wisdom of paying a $12,000 fee, we have to include the interest cost benefits as well.
The average interest rate of the unsecured debt that was paid down was not mentioned, but she did say that $45,000 of it had interest rates from 6% to 10%. For argument sake, let’s assume that the average interest rate of all the $59,000 debt she paid off was 4% higher than her mortgage rate.
In other words, she paid $12,000 to decrease the interest rate of $59,000 of debt by 4%.
As to whether this was a good move or not – we have to consider how long she would have taken to pay off the $59,000 of unsecured debt, had she not used part of her down payment money to pay it off.
4% interest on $59,000 for one year is $2,360. If she doesn’t pay the principal down at all – it will take five years for the interest saved to equal the CMCH fee. After that, she will have saved money by using a smaller down payment.
If she would have paid down the $59,000 quick enough to keep the total excess interest (4%) cost below $12,000, then she would have been better using 20% down and avoiding the CMHC fee.
Of course, it’s impossible to know what the future holds, but I would suggest that in Madhavi’s case, it’s likely that paying a smaller down payment and paying the CMCH will have a neutral or positive outcome.
The reason I say that is because if you buy a house when you have a lot of unsecured debt (at least $59,000 in Madhavi’s case) and it appears that the house cost itself is a stretch – I don’t think it’s likely that they would be in a position to pay off extra debt very quickly.
Had they put 20% down and saved the CMHC fee, they would have had higher monthly payments, probably would have taken quite a while to pay down the unsecured debt and would have paid more in extra interest than the CMCH fee cost.
What if I don’t have any or much unsecured debt and have to borrow to reach 20%?
Madhavi bought a house with a huge amount of unsecured debt. I suspect it is more common for people to buy houses who have little or no debt (other than an existing mortgage). For this scenario, the numbers change quite a bit and it is a lot more likely that if you can borrow enough money at a reasonable rate to make the 20% down payment, you will come out ahead.
What if I have the 20% down payment, no debt, but need some money for other things?
If you have the cash for 20% down payment already and little or no debts – it’s a no brainer. You must use the cash for the down payment and then just borrow any money you need for closing costs, furniture etc.
Rob Carrick wrote about a Vancouver couple who sold their house recently with the idea that they would rent for a while and then buy back into the real estate market after the coming crash.
I know a couple who did this same move in Toronto. They might make out like bandits in the end, but the fact that they are on year seven of their plan makes me wonder.
After being a home owner for most of the last 12 years, I’ve gotten tired of it. I hate the costs and all the hassle that houses bring. However, I’m not planning to sell, since I’d probably find just as many things to complain about with a rental.
One thing I’m definitely not contemplating is trying to time the real estate market by selling my house now and buying again in the future at a lower price.
It’s easy to think that if you sell your house for high price and buy it back again at a discount, it’s a worthwhile thing to do. And it very well might be. But can you do it?
Let’s look at what kind of real estate drops would make this move worthwhile and then analyze some different outcomes to see what kind of benefit or loss a home owner might face if they try to time the market.
I’m going to assume a transactional cost of 10% of the selling house price. This could vary greatly, but I’m talking about all costs – real estate agent fees, moving costs, incidentals etc. If you don’t agree with this number, then just substitute your own.
I’m also going ignore a whole pile of other factors like money earned on house equity while renting as well as the fact that someone renting might rent the same house or they might downsize to save cash.
First off – I’m going to use a fictional house in downtown Toronto which is currently valued at $650,000. I’m going to pretend this is my house and I want to figure out what kind of market drop I need to make it worthwhile to sell and wait out the crash.
10% house price drop
Well considering I’ve said the transactional cost is 10%, clearly a 10% drop doesn’t do anything for me. I would end up buying back into the market for net gain of zero. That’s a small reward for moving twice.
This results in a net gain of $32,500. Forget it – this isn’t close to making it wortwhile for me.
20% house price drop
Net gain of $65,000. Not bad, but still not enough to get me to do this.
25% house price drop
Net gain of $97,500. Ok, now I’m interested. Almost $100,000 of after-tax money is pretty appealing.
How’s your sense of timing?
One problem with my scenarios so far is that I’m assuming I sell my house at the exact peak of the market and then buy again at the exact bottom of the market. Obviously, this isn’t going to happen.
I suspect that to take advantage of a 25% house price drop, I would need the market to drop a lot more. 30% at a minimum and a 40% drop would be much better. That way I don’t have to time the market perfectly.
So in other words, I would need a house market drop of around 40% and be able to time things reasonably well in order to profit enough to make the whole exercise worthwhile.
Not a small order. Even if you think the market is going to fall, do you know the timing of the that fall? Will it drop enough to make it worthwhile for you? How long will the market drop take?
In my case, it’s very, very unlikely that the market will fall enough and my timing be good enough to do something like this.
Downside – What if you are wrong?
The big downside of this strategy is if you are wrong, you could end up with an insignificant profit which won’t compensate you for all the hassle involved. Or worse, you lose money. Maybe a lot of money.
Let’s look at some non-rosy scenarios:
You buy back in at a price that is 15% lower
In this case, I’ve packed up the house, rented for a certain amount of time and then decided to buy again. I’ll make about $32,000 which is not horrible, but not that great.
Housing market remains flat for a long time and you decide to get back in
In that case, the $650,000 house is still $650,000, but you have paid 10% in transaction/moving costs, so to buy the same house means you are $65,000 poorer and you’ve gone through the hassle of moving twice.
Market continues to climb and you (or your spouse) panic and want back in
If the market has gone up 15%, the $650,000 house is now $747,000, you’ve paid the transaction costs and are back in your old house and you’ve lost a total of $162,000 for your troubles.
If you can forecast a big enough drop in house prices and you can time it well enough to benefit from most of the drop, selling and renting for a while could be quite profitable.
The way I look it, there is too much downside risk for most people. Yes, you could make a good chunk of change if things work out, but you can easily lose just as much money. If you want to play roulette – go to Vegas.
Real estate cycles can be incredibly long. Think of the timing – what if you had done this five years ago – how would you feel now? Would you still be married?
There are some hot real estate markets in Canada, namely Toronto and Vancouver. One of the results of a hot market is a tendency for sellers to underprice their houses in order to create a bidding war. This benefits the seller because it speeds up the selling process and they might get an above-market sale price if the bidders get carried away.
Some buyers feel that sellers are behaving inappropriately or even unethically by underpricing their house. My opinion is that buyers have to deal with the real estate environment as it is and need to figure out how compete effectively for a house, rather than worry about ethics or the fact that bidding wars are “not the way it’s supposed to be”.
Asking price is meaningless
The first thing to realize is that the asking price for a deliberately underpriced house is meaningless. Just ignore it, except as a very general guide.
You are “negotiating” against the other bidders, not the seller
Traditional house purchasing negotiation is between one buyer and one seller – the asking price sets the intent of the seller and negotiations start from there.
In a bidding war, the seller may control the process, but they take themselves out of the negotiation process. The auction is between the potential buyers, who don’t directly negotiate against each other, but are competing amongst themselves to buy the house.
A bidding war (intentional or not) effectly removes the relevance of the asking price and allows the bidders to determine the selling price of the house. By pricing the house too low, the sellers might as well set an asking price of zero and let the potential buyers figure out what the house is worth.
On a related note, a friend of mine successfully sold his house recently using the 5-day method which requires the seller to set the “asking” price to 50% of the estimated market value and then let the bidders determine the fair market value.
To compete effectly against your competitors in a house bidding war, the best things you can do are:
As I mentioned here in Things to think about when buying a house, don’t fall in love with a house before you own it. There are other houses for sale and if the price goes too high – don’t be the idiot who overpays. Walk away if you have to. Your agent won’t be pleased, since as I wrote about in why you can’t trust your real estate agent when buying a house, at the point when you are bidding for a house, your agent is your enemy – not your friend.
Learn how much houses are worth
Knowing the market means looking at enough houses in your target area and their eventual sale prices (ignore the asking prices) to be able to determine how much a house might sell for.
Consider your appraisal value as the “asking” price for that house and go from there. Ignore the seller’s asking price. Ideally you should determine beforehand what your upper limit is and stick to it. I’m not sure how realistic that is. If you are in a hot bidding war, I would figure out your upper limit and make that your first bid. If necessary, just do small increases after that, but don’t exceed your upper limit by much.
The two biggest mistakes you can make with a bidding war are:
Paying more than you can afford. Solving this take discipline.
Winning the auction by a large margin. This means you overpaid.
Ignore the other bidders
It can be intimidating to go up against a lot of bidders for a house, but don’t assume that all of them are rational bidders. There were 14 bidders when I sold my first house and I can tell you out of that group – only three were really in the running. There was another group of about four that had reasonable bids, but not good enough. The remaining seven bidders were all under market. The house was very comparable to a few recent sales and any good agent should have known that those bids were a waste of time. Ironically, one of the lowest bids was from a real estate agent.
Some bidders are irrational on the other extreme – they will pay whatever it takes to get a house. Whatever you do, don’t be this person and don’t compete against them. There aren’t a lot of fools with a lot of money (for obvious reasons), so rest assured that if you are bidding against one of these crazies – just move on to the next house if things go too far past your limit.
I’ve heard friends claim “I’ll never get into a bidding war“. This doesn’t make sense to me. It doesn’t matter if a $500,000 house has an asking price of $450,000 or $550,000 – it’s still a $500,000 house and the asking price is wrong. In either case, just ignore the posted price and proceed with a proper bid.
You can remove the auction element of the buying process by knowing how much the house is worth and just bidding that amount. If the bid isn’t accepted, move on. If you lose out on a lot of houses, clearly your appraisal method needs some revising.
My wife and I were involved in a bidding war when we purchased our current house. Because of the research I had done, it was clear that the market value of the house was about 8% above the asking price. We bid that amount and bought the house. Now, to be clear, we didn’t ‘win’ the auction because of my research, but knowing the true house value allowed us to make a rational offer and not feel like we were overpaying.
Interestingly enough, the seller turned down a higher offer because that bidder wanted to knock down the house. We were planning to fix it up (it was a wreck) and since the seller had grown up in the house, he took our offer instead.
To sum things up…
The winner of a house auction is not necessarily the person who buys the house.
As a home owner, I’ve seen various methods of estimating annual home maintenance costs. These methods involve calculating a percentage of your home value – usually between one to four per cent, and using that value as the annual maintenance estimate.
Being a bit of a skeptic, I never had much faith in these estimation methods, since there is never any kind of logic to them or analysis supporting the numbers.
It doesn’t make sense to me that your home value should determine maintenance costs, especially if you live in an area where the land value is the majority of your house value. The cost of maintaining your land is far less than the cost to maintaining a house.
Another problem with these estimates is that a poorly maintained, older home will be worth less and consequently have a lower estimated maintenance cost than a new, well-maintained house – clearly this makes no sense at all, since the poorly maintained house will likely need more maintenance and should have a higher estimated maintenance cost.
A third issue is that from a budgeting perspective, home maintenance often involves high cost items that occur infrequently. For example; a $12,000 roof that lasts roughly 20 years. Calculating an annual cost for that roof might be an interesting exercise, but it’s unlikely to actually help you efficiently budget for it. And will you still be living in that same house 20 years from now?
A better way to calculate your home maintenance costs
A better method is to look at the major components of your house that will need replacing at some point and do the following steps for each component:
Estimate the replacement cost
Determine the life expectancy
Determine the current age of each item
Calculate the estimated remaining life expectancy
Rank the house components in order of increasing estimated remaining life expectancy and then plan for any expenses expected in the next five years.
Watch for any upcoming “expense clusters” – A high amount of maintenance costs in a short time period
Let’s do this exercise for my house
First I will list all the big items in my house that will need replacing at some point:
Gas stove
Refrigerator
Dishwasher
Dryer
Washing machine
Deck
Furnace
Air Conditioner
Gas water heater
Roof
Gutters
Windows
Fencing
The next step is to determine the estimated life spans.
Then we find out the current age of each component.
The current age of most of my items was fairly easy, since a lot of them were replaced just after buying the house. For older items, you can often look on the component itself to see if there is a date on it. Windows, furnaces, air conditioner, hot water tanks should all have a date on them somewhere.
If you don’t know the age of an item, just take a guess. For example if you bought your house 12 years ago and haven’t replaced the roof, there is a very good chance that the roof is at least 12 years old. 🙂 If the roof isn’t falling apart or leaking, it’s probably less than 20 years old. Pick a number halfway between 12 and 20, say 16 years and there’s your estimated roof age.
Now we need to figure out the replacement costs.
This can be difficult since there can be a wide variety of options when replacing an item. I wouldn’t worry about trying to get accurate figures – for this exercise, any reasonable guess will do. Once you get close to replacing a component, then you can worry about the exact cost.
If you are really clueless about how to collect any of this data, see if you have a copy of the original inspection report which should contain some of this information. A more expensive option is to hire a home inspector to check out your house – they can give you an idea of the condition, age and replacement cost of the various parts.
Calculate “Remaining life expectancy”
Finally, I need to calculate the “Remaining life expectancy” for each item by subtracting the current age of each item from the life expectancy. For example if my roof is 14 years old and the life expectancy is 20 years, the “remaining life expectancy” will be 20 minus 14, which is six years.
Here is a table showing all my major maintenance costs, ages and life expectancies. Note that I put in a “purchase year” for each item, so that I can look at this table again in a few years and the current age (calculated) will be automatically updated. Most of my estimated costs are very ball park.
Just for fun, I took all the items, calculated an individual annual cost and summed that up to get an idea of my average annual maintenance costs. It came out to $3,186 per year. Throw in a few bucks to cover smaller maintenance costs not listed and my annual house maintenance costs are $3,500 per year. But as we’ll see later, that annual figure is not very useful for planning or budgeting.
My maintenance expenses
Now that we have all the data we need – let’s rank all the items by the remaining life expectancy so we can get an idea of upcoming maintenance expenses by time period.
I suggest that you focus on the next five years only. Beyond that is just too far in the future. Most single maintenance items are not so expensive that five years isn’t enough to save up for them.
Look at any expenses in that five year time period and think about how you can plan for them. If your budget is tight and you need a furnace in four years, setting aside some money each month might be a prudent idea. On the other hand, if you have a high savings rate and a decent emergency fund – perhaps you can wait until closer to the actual replacement date to save some cash or even just buy on credit and quickly pay back the loan. The estimated life expectancy dates are not very accurate, so you don’t want to have $5,000 cash sitting around waiting for a furnace to die, if you have better uses for that money.
It’s also worthwhile to look beyond five years for the case where there are a lot of items up for replacement at the same time (“expense cluster”). This situation could require more advance planning (which could include moving). This might happen where someone moved into a new build home or did major renovations.
Ok, let’s get back to my case study:
Maintenance items by time period.
I’ve ranked the items by the expected expiry dates. While I’m mainly going to focus on items that need replacing in the next five years, I’m also going to note the “expense cluster” that I’m going to face in about 12 years.
Now I will look at the list and do some planning.
These two items are overdue for replacement:
Air conditioning – This item is old and could die any minute. However, it works fine and I’m not planning to replace it until it stops working. Because of our emergency fund and high savings rate, the $3,500 replacement cost will not be an issue. Action plan: Monitor indoor air temperature on hot days.
Deck – My deck might actually be a funny story if it belonged to someone else. It is ancient – I’ve estimated it’s 21 years old, but it could be 50 for all I know. Every year I replace a couple more rotten boards. The reason I haven’t replaced the deck is because we have water problems with our basement that will be addressed in the future. There is no point in getting a new deck if we might need to dig up around the house for water proofing. When we tackle the basement project, a new deck will be included in the budget at that time. Action plan – Keep rebuilding deck one board at a time.
The following items are due for replacement within the next five years:
Refrigerator, dishwasher, gas water heater, washing machine – These items have a total replacement cost of almost $4,000, which is not a worrisome amount. Given that the estimated expiry won’t happen for at least four years, I’m not going to worry about these expenses at this time. Action plan – Nothing.
Fence – This is another item I have no idea of how old it is. It’s not in bad shape and the reality is that I will probably just do small repairs if it starts having problems. It’s extremely unlikely that the fence will get replaced anytime in the next ten years. Action plan – Don’t lean on fence.
All the remaining items have expiry dates that fall outside of my five year window of concern, so they will be ignored for now. I will take note of the last four items in the list – furnace, windows, roof and gutters. These items represent $35,000 of costs within a 3.5 year window. This is what I was referring to when I mentioned the idea of an “expense cluster“.
This expense cluster will eventually require some planning, but it’s still too far off (11+ years) to plan for now. It’s likely that we’ll start saving an extra $5,000 per year starting a year or two before the cluster hits in order to be able to pay for those expenses.
This exercise shows why an annual maintenance estimate is not very useful. In my case, I don’t have a lot of costs coming up in the next several years, so if I saved $3,500 per year – that cash would be sitting around doing nothing. I’d much rather put it into my mortgage. Conversely, if you have a house where there are a lot of upcoming expenses, the $3,500 per year budget probably won’t be enough.
Conclusion
Because I have a decent emergency fund and a high savings rate, I don’t need to do any kind of special budgeting for house maintenance now, since I don’t have a lot of costs coming up in the next few years. Someone with a tight budget might have to set aside a “house maintenance” fund to handle these costs.
Every house will be different – It’s important to analyze the components of your house in order to plan out your future house maintenance costs.
Some more thoughts
This concept of future budgeting can include items other than house maintenance items. If you are planning/hoping for renovations in the future – add them on the “maintenance calendar” as well. Even big ticket non-house items like new cars, “trip of a lifetime” vacations can be added in.
Specific budgeting for future items is not always practical. If you just bought a new roof for $10,000, are you really going to start saving $500/year in a “roof fund” for the next 20 years? That’s just not a good use of your money.
One of the best ways to deal with future expenses where it’s not certain about the timing is to have an emergency fund and a high savings rate. Anything you can do to improve your current financial position will help you deal with future expenses.
Problems with using percentage of home value estimates with examples
Land value skews the estimates
As I discussed in this post; How to value real estate, the land value can make up a majority of a house purchase price. Especially in an urban setting.
Using a percentage estimate for a maintenance budget means that a home owner in a popular area will have a higher maintenance estimate than someone who lives out in the country and has a lower land value.
For example – Take a two-story 1,200 square foot house. Let’s say the house value (not counting the land) is $150,000. If this house is sitting in an expensive area of Toronto, the total value might be $700,000. If the house is out in the country, perhaps the total value is only $200,000. If we use a maintenance estimate of 2% of the house value, that gives us $14,000 per year for the big city house and only $4,000 per year for the country house. Given that this estimate methodology gives us two very different results on identical houses indicates that it’s quite flawed.
Older, crappier houses will negatively influence maintenance estimate, but probably need more maintenance.
If we ignore land value, a house that is in great shape will be worth more than a run-down house that needs lots of maintenance. The percentage estimate will incorrectly conclude that the run-down house needs less maintenance, which is nonsense.
Example – Let’s take our $200,000 country house which is made up of $50,000 land and a $150,000 house. This house is very well maintained. Let’s say there is a very similar house on the adjacent lot, except this house is much older and hasn’t been well maintained. The second house is only worth $150,000, which is made up of $50,000 land and a $100,000 building value.
The percentage estimation method will tell us that the well maintained house should have an annual maintenance budget of $4,000 (2% of $200,000), but the run-down house only needs $3,000 per year (2% of $150,000). This is clearly incorrect, since it’s very likely that the cheaper house will need more maintenance.
How do you budget for home maintenance? Anyone else miss the good old “rental” days?
The recent agreement to open up the MLS real estate database to agents working for a flat fee, means that it will be lot easier for people to sell their homes without hiring a commissioned agent.
Previously, sellers without commissioned agents couldn’t list their homes on MLS which made selling without an agent, a lot more difficult. From my experience, most buyers use MLS as their exclusive search destination when looking for potential houses.
Benefits for sellers
This change allows home owners to sell their house without paying an agent up to 2.5% for the privilege of listing on MLS. Even if they pay a buying agent up to 2.5%, they can still save quite a bit of money.
It will be interesting to see if the standard 2.5% for the buyer’s agent continues or if that gets changed to a fixed fee as well. What would make more sense to me, is for buyers to pay their own agent for services rendered. Maybe buyers should pay for each house viewed?
Benefits for buyers
This might make it easier to buy a house without an agent. However, since the invention of dual-agency status (otherwise known as double-dealing) this benefit might not be very significant since it’s pretty easy to buy a house without an agent.
Give me access to MLS sales data
At one time I had full access to the MLS sales data, due to the generosity of a friend. As I was changing houses at the time, this information was invaluable. I would hate to pay an agent a huge chunk of money just to get access to comparables, but it might just be worthwhile.
What I’d love to see is an option for someone to pay for an MLS login. If I was in the process of buying or selling my house, I would have no problem paying $50 per month to be able to look at relevant sales data.
So how about it CREA? Sell your data before Zillow starts doing it.
Will this result in lower real estate fees?
No. In the US, this change happened a few years ago and commission rates for real estate agents have not gone down. The only difference is that people who want to sell their home on their own have an easier time doing it.
This is analogous with the Canadian investment industry. At one time, there were no do-it-yourself cheap options for investors. Now we have discount brokerages, cheap ETFs and index funds. Has this lowered the price for the “full-service” investment model? No, all it means is that if you are willing to do it yourself, you can save a bundle of money. Most investors choose not to do that.
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?
I was recently up at my condo (there have been problems with the fuse box, the dryer keeps blowing out fuses) and I got talking to one of the neighbours I’ve seen up there a few times. He was quite interested in what I’d paid for the condo and has told me repeatedly that he wants to sell his 3 bedroom condo (and usually says he wants to sell it to me and tries to get an offer from me).
I’ve avoided the subject in the past, and have just reminded him that I got a really good deal on the condo I bought (which is why I bought it) and that prices in the building aren’t going up quickly (he paid $174K for his 3 bedroom years ago and there are similar units in the building being listed for that now). I mentioned this to him and warned him that it’d be tough to get a lot more then he paid for it from his unit.
Finally he managed to wear me down and I admitted to him that I’d run the number and if I was putting an offer in on a 3 bedroom condo in that area it would probably be for about $140K. At which point, of course, he looked shocked and offended and said “if there was a unit selling for that in the building *I’D* buy it!”.
The joke is, there WAS a unit selling for such a deep discount and it was his neighbour’s! of course, he didn’t put an offer in (I did and bought it).
People often seem to fall in love with one form of valuation and decide that its gospel. If your neighbour got a certain price for their property, by golly that’s what you should get too! Or if an appraiser says your property is worth $X, then $X is the MINIMUM you should accept (even if your property has been sitting on the market for 8 months with no offers).
The way I evaluate a property is much like the violent acres post, I take the rent and work backwards, deducting expenses until I figure out how much cash is available for a mortgage, work out how much mortgage that could afford in the current environment, and hope to get the property for less than that. I understand however, that just because my valuation technique says a 3 bedroom condo in that area is worth $140K, people may or may not accept it.
Ultimately something is only worth what someone else will pay for it (and what someone will sell if for). Given, that people overpay (or sell too cheaply) all the time, even this isn’t even an perfect valuation technique.
People getting locked into the view that there is only one approach to valuation (and they’re angry at anyone who doesn’t use it) makes me scratch my head.
