Remodeling areas of a single-family house is an excellent way for homeowners to add increased functionality and beauty to a property at someone else’s expense. A significant portion of the cost can be passed on to future owners in the form of increased property values if you choose the right project to enhance your living space.
- Remodeling can boost the return on investment (ROI) of a house. Wood decks, window replacements, and kitchen and bathroom upgrades tend to generate the highest ROIs.
- Remodeling projects must generally fix a design or structural flaw to earn back the cost of construction.
- The cost of renovating rental properties can be recouped during a sale but also with the increased rental rates that can be commanded by updated homes.
- Home equity loans are one way to finance renovation projects, allowing for interest-only payments until the property is sold and the costs are recouped.
- One of the biggest mistakes is improving a home well above the average for neighboring houses because home prices tend to reflect the tastes of local homebuyers and the amount they’re willing to pay.
What to Consider Before Renovating
The 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.
Certain projects have historically and on average shown the greatest ROI regardless of the property’s location or the state of the residential property market. They include the addition of a wood deck, kitchen and bathroom upgrades, and window replacements.
Bigger renovations aren’t always better because spending more doesn’t always ensure greater value creation.
It’s unlikely that a homeowner will earn back more than the cost of construction unless the remodeling project is designed to fix a structural issue or a design flaw. Homeowners should consider the tastes of prospective purchasers when deciding which projects to pursue if cost recovery is as important a consideration as increased enjoyment from enhancing the property.
But homeowners should be careful about which projects they choose to complete because the potential value gains can only be realized to the extent that buyers are willing to pay for the renovations. And investors must be certain that any additions will fit into the existing space before the value of renovations can even be considered. This is something that the best home design software can help with.
The cost of enhancing can be recovered by investors who are remodeling rental properties not only at sale time but also through the increased rental rates commanded by updated residences.
Consider Your Location
It’s essential to ensure that the improvements made are appropriate for the particular type of dwelling and the local property area. One mistake homeowners often make is improving their homes well above the average for neighboring houses.
Buyers are typically attracted to particular neighborhoods because of the services located nearby and because houses in that area are selling within that buyer’s price range. A house improved well above others nearby may still receive the same level of interest compared to others being marketed, but it’s unlikely that it will command a premium well above average simply because of the extra improvements.
How the Government Can Help
Mortgage interest is tax-deductible so Uncle Sam may help to subsidize home improvements, making the cost of construction even less burdensome for property owners.
Less risk-aversive property owners who have accumulated adequate equity in their homes can use financial instruments such as a cash-out refinance or a home equity loan to finance their construction projects. The only cash necessary to complete the planned projects would be the interest payments to maintain the loans, which can be tax deductible. The principal can be repaid when the property is sold.
IRS rules apply to the mortgage interest tax deduction. The value of the home can be no more than $750,000 and the proceeds of the loan must be used to “buy, build, or substantially improve” the home that secures the loan.
Project Returns on Investment
The ultimate reason to take on any home remodeling project as an owner-occupant is the enjoyment you’ll receive from living in an updated home. Several sources offer insight into expected payback on specific projects for those who are hoping to also profit from remodeling.
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 in place at the time, as well as the average cost of construction.
Table 1 contains national average estimates but homeowners can find more specific information at Remodeling Online, offering the same estimates for different geographic areas of the U.S. These average payback ranges for the most common remodeling projects can give prospective sellers a broad indication of which projects have the greatest probability of returning a bulk of the project cost at the time of sale.
Differentials in average recoveries are explained by the scope and quality of the work performed. Smaller, less useful projects are on the lower end of the range.
|Average Renovation/Remodeling Cost Recovery
|Average Cost Recovery
|Wood Deck Addition
|Minor Kitchen Remodel
|Major Kitchen Remodel
|Attic Bedroom Remodel
Source: Remodeling Online
Improvements such as office and bedroom remodeling had the largest recovery ranges from 50% to 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 a guest bedroom versus a master suite.
What’s the Difference Between Renovating and Remodeling?
The terms “renovating” and “remodeling” are often used interchangeably, but Home Depot says they’re quite different. Renovation is the process of bringing a room or dwelling in poor or iffy condition up to good condition. It changes the quality of the room rather than the room itself. Remodeling is the process of making major structural changes.
How Much Do Americans Spend on Home Renovations?
The Joint Center for Housing Studies of Harvard University puts the figure at more than $500 billion a year. The spending trend is toward creating healthy and energy-efficient homes.
Will I Need Legal Permits to Make Renovations to a Home I Own?
In some cases, yes. The deciding factor is typically the safety of any changes you’re making. Structural, roof, plumbing, and electrical changes often require permits from your local government. Your contractor should be able to take care of this paperwork for you.
The Bottom Line
Homeowners should consider the value they’ll receive from any remodeling project over any cost recovery that might be available from a sale. But they should research local real estate guides to determine which projects are most likely to pay for themselves when contemplating two equally useful changes.
Remember that bigger is not always better and spending more does not always ensure a greater degree of value creation. Home prices will always reflect the tastes of local property buyers and the amounts that those buyers are willing to pay in a particular neighborhood or subdivision.