Before You Renovate Your Home, Do the Math
David M. Bowman
Thinking about renovating your home to boost its market value? You’re not alone. In the first quarter of 2017, the Remodeling Market Index, compiled by the National Association of Home Builders, reached 58. That’s close to its historical high and is its strongest showing since the fourth quarter of 2015. 2018 is expected to be no different.
But, before you hire a contractor or head for your nearest home improvement store, be sure to consider your options. Some projects pay off better than others when it’s time to sell your home.
The fact is that few homeowners completely recover the costs of their remodeling projects. In 2017, the average cost-to-resale-value ratio for remodeling projects was 64.3%, according to the 2017 Cost vs. Value Report from Remodeling Magazine. So, for each dollar that homeowners invested in a project, they captured 64.3 cents when they sold their homes. Obviously, this number will fluctuate with the economy and the housing market in your area. For example, back in 2005, the average cost-to-resale-value ratio was a whopping 80%.
It also becomes more difficult to recoup project costs completed many years before a house is put on the market. The same holds true for projects that are out of sync with the home’s value overall, such as installing a commercial-grade kitchen in a starter home.
However, even if your project’s cost isn’t completely recouped when it comes time to sell, some renovations and upgrades may cut the length of time your house stays on the market. That is particularly true if your home otherwise would lack certain features, such as a finished basement or outdoor deck.
Often, it’s cost-effective to focus on replacement projects. These generally have lower price tags than larger undertakings, such as completing an addition. Additionally, many replacement projects can give your home’s curb appeal an immediate boost, which helps get buyers in the door, translating to a higher sale price.
For example, the Remodeling Cost vs. Value Report indicates that the only project that returns a higher value than its cost nationwide is putting loose fill insulation in an attic. Installing a steel entry door and applying manufactured stone veneer to an exterior come close, allowing homeowners to recoup an average of 91% and 89% of their costs, respectively. In general, exterior projects, such as replacing windows and siding, generate higher returns than interior projects—an average 75% vs. 63% payback.
Furthermore, not every home improvement project has high upfront costs. Simply stripping outdated wallpaper and repainting a room can be a fairly quick and inexpensive way to get a fresh look. Rather than redoing an entire bathroom, update it with new hardware and lighting. If carpets appear dirty but are still in good shape, have them professionally cleaned. In fact, if you’re ready to sell, the most effective way to attract buyers is practically free—thoroughly clean and de-clutter your home.
One of the biggest factors in valuing renovation projects is location. In a nutshell, the stronger your local real estate market, the better your project is likely to pay off. For example, In San Francisco 21 of the 29 projects tracked by the report returned at least 100% of their costs. But, in one-third of the country, no project recouped expenditures.
Keep in mind that few remodeling projects can compensate for a structure that has not been properly maintained. Although prospective buyers may “ooh” and “aah” over granite counter tops and stainless steel appliances, many will hesitate to place an offer if the furnace isn’t working properly or if the wiring needs major upgrades.
Enjoy Your Home
If you plan to live in your home for a while and have your heart set on building a master suite or luxury kitchen, do it. You may not be able to recoup 100% of the cost when you go to sell, but it’s important to look at the project comprehensively and what it means for you and your family, not solely on the ultimate return on investment.
Sidebar: Selling? How to Qualify for the Capital Gains Tax Exclusion
Selling a home that has significantly appreciated in value can trigger capital gains taxes. However, you may be able to exclude up to $250,000 ($500,000 for married couples) in capital gains. To qualify for this tax break, you must have:
- Owned your home for at least two years;
- Used it as a principal residence for at least two of the five years preceding the sale; and
- Not have claimed the exclusion within the last two years.
If an unexpected life change (including death and job loss) forces you to sell your home in less than two years, a pro-rata exclusion amount based on the length of your residence may be available. Also, in what might be considered a bonus tax break, any capital gains eligible for the $250,000 home sale gain exclusion are also excluded from the 3.8% net investment income tax that currently applies to certain higher-income taxpayers.
For more information, contact David Bowman at firstname.lastname@example.org or 312.670.7444. Visit ORBA.com to learn more about our Wealth Management Services.