As I wrote earlier, given my finance background, I never embark on a home renovation project without calculating its Return on Investment (ROI). I measure ROI as the estimated resale value increase from the home project divided by the budgeted cost of the project. Calculating the return on investment of every home update is a sanity check that it is a good current use of money, and besides current personal enjoyment, I will get some of my investment back when the time comes to sell my house.
As a finance professional, I often chased “alpha,” or above average returns. As a home owner or realtor, I seek to do the same for home improvements.
Generally, return on investment on most home renovation or update projects is less than 100%, since home improvement is typically undertaken to factor in the homeowners’ immediate personal enjoyment. For example, oftentimes a kitchen is upgraded because the owner fancies granite countertops or professional-style appliances, thus resulting in average ROI of about 65%-75% . This means than most future buyers only partially subsidize the cost of the home improvement.
So, how do I get above average returns on home improvements? Mathematically, there are two ways on increasing ROI. First, you increase the resale value of the house. This is literally increasing the “wow factor” that potential buyers would pay up for, despite the fact that the current homeowners did not spend extra on the project. For example, suppose one homeowner chooses a widely liked tan color and second chooses orange to paint their living room. Both pay $500 to the painter. The first project is expected to have a higher ROI since the neutral color would appeal to more buyers. Second, and this is more in the hands of the homeowner, is to reduce the cost of the project below the average cost of similar projects undertaken by comparable homeowners.
Shopping around for lower labor costs
I recently undertook a rather comprehensive renovation project for my home. I got estimates from three general contractors: one who appears on reality TV, one who I have worked with previously, and one who came recommended from my boss. While the last two provided labor costs that were comparable, the “star” contractor’s estimate was $14,000 more. Clearly, choosing a overpriced contractor would lower my ROI below average.
Shopping around for lower cost of identical materials
A few years ago, I was shopping for some custom Hunter Douglas blinds. Again, I got three quotes, two from local merchants (one of which had an upscale retail location while the other was in a rent-controlled warehouse building), and a national company that advertised on TV. Here for almost the identical product, the Hunter Douglas dealer who operated out of a low-cost location priced almost 40% lower than the most expensive, easily saving me over a thousand dollars. I tend to increase the return on investment of my home renovation projects by eliminating the middleman and going to the source, even if it means shopping in less glamorous locations.
Understanding what the buyer will pay up for
In my town, three bedroom condominiums on more desirable streets are scarce and therefore in great demand. In fact, the premium for a third bedroom is at least $30,000 and sometimes up to $75,000. Bedrooms are relatively easy to create, since local building code only requires a certain minimum size, a door, and a closet. Therefore, some of the highest ROI projects involve dividing a larger space into two rooms, or building a closet in a den. While building a closet returns only 55% by my calculation, this is one instance where spending ROI could easily be 100% if the closet converts a den into a bedroom.
Disclaimer: The author has a real estate salesperson license in New Jersey and is a Chartered Financial Analyst previously employed in the financial services industry.