Property Grunt

Sunday, April 30, 2006

Returns on renovation

New York Times article on Returns on Renovation is an excellent primer for anyone interested in renovating their homes. It also touches upon the law of dimishing returns which I have covered in a previous entry.

Here is a link to the article.

Last November's report, which also appeared in the December issue of Realtor magazine, said a minor kitchen remodeling would cost $14,913 and return 98.5 percent of that investment when the house was sold. Adding a midrange master bedroom suite, with a walk-in closet and dressing area as well as a bathroom, would cost $73,370, with only 82.4 percent of that being recouped. A modest bathroom redo, costing $10,499, could earn back 102.2 percent of the investment, Remodeling said.

The magazine acknowledged that the projections of return on investment were reliable only on the broadest regional or national level. The estimates for its return-on-investment data come from a survey of about 1,600 real estate agents and appraisers. That is a reliable sample size, but it is often too small to provide reliable estimates on a city level, said Grant Farnsworth, president of Specpan, the Indianapolis company that manages the survey.

Mr. Baker said researchers at the Harvard center "threw up their hands" after trying to determine the return on investment of remodeling projects. "How a bathroom renovation affects value depends on a lot of things that are hard to quantify," he said. "To do it well, you need neighborhood level estimates, but that would be very difficult."

Consider, for instance, the question of adding a bathroom. The Remodeling magazine report estimates that it would cost $22,977, with a 86.4 percent return, at best. But agents may say that a house with one bathroom in a neighborhood where two bathrooms is the norm is at a disadvantage when the house goes on the market. Mr. Baker said that the homeowner might then see a good return on the investment by making the house competitive. But, he said, someone adding a third bathroom to a house in that neighborhood might get little return.

If a bunch of brain cases from Harvard are unable to figure out the return on a renovation, then you can be sure as hell this isn't a simple matter. Unfortunately, return on renovations, particularly for residential, is quite subjective. You have to make sure that you are not following the law of diminishing returns.

You could call that keeping up with the Joneses, but it is an essential rule of remodeling, architects and remodeling contractors said. "I encourage people to think about what the mainstream is doing," said Mark G. Richardson, president of Case Design/Remodeling, one of the largest firms in the country. "Your tastes may be a liability."

As far as I am concerned, this is the best piece of advice. You have to be aware of your own tastes and to accept the fact there maybe a risk in expressing them in your home. So exercising restraint may not be a bad thing.

"Do the renovations you want and don't worry too much about resale," advised Mr. McDonald, who now does remodeling for others. "Someone will appreciate your fantastic kitchen, and you get to enjoy it in the meantime."

Bulls**t. Mr. McDonald can jabber on about what works because he got a very nice return on his renovation but even he is unsure if his renovations were the reason why he suceeded.

When Mike McDonald and Jill Martenson bought their little Craftsman house on Locksley Street in Oakland, Calif., in 1999 for $325,000, the couple knew it needed a lot of work.

"It was the worst house on the block," Mr. McDonald said.

He and his wife pulled off the vinyl siding, threw away the plastic shutters and stripped layers of paint off the interior Douglas fir woodwork. Then they rebuilt the front porch, reshingled the house, rewired it, added copper plumbing, a bedroom and two bathrooms. Their kitchen remodeling included trendy concrete countertops and cherry cabinets.

Mr. McDonald said he was not quite sure of the exact cost of the six-year project but that it was probably around $300,000.

This month they sold the house for $1.15 million, $155,000 over the asking price. "Whether it is the hot real estate market or my brilliance, I don't know," he said.

If you want to increase your chances of getting a better return on your renovation, you need to follow these principals.

1. Buy to sell.

Whether you plan on living in your new home for one day or 10 years, renovate it so that that you can easily sell it on the market. Whatever personal touches you put in your apartment, be sure that they are acceptable or they can be easyily reversed.

2. Bathrooms and Kichens. Those are the areas that are utilized the most and are often the focus of renovation. Make an effort to put those areas in order so they look presentable.

3. Look at the buyer's perspective when you renovate. When a buyer is looking at an apartment, they are going through their head of how much it will cost to potentially renovate the property. That also includes getting rid of whatever renovations the previous owner has done. On top of paying for the property, they also have to factor in the cost of renovating the apartment. If it looks it is going to cost them an arm and a leg to change the apartment to their liking, they may not bite.

4. Stick to the basics. New paint, fixtures and anything that can brighten up an apartment are essential and quite simple to implement. These are the things that buyers look at.

5. Understand external and functional obsolecense. In the appraiser world these are very important concepts that used daily in their work. External Obsolecense is defined as

External obsolescence refers to conditions occurring off site, that negatively value. For example, many power plants suffered external obsolescence immediately following deregulation, because their new lower or riskier income under deregulation no longer supports their cost of construction.

Here's an example. I know of an amazing apartment with a brand new kitchen and Italian marble slapped everywhere. However it has horrible views and no light. What happened was that the sellers thought by concentrating their efforts on renovating the apartment they figured that it would overcome the weaknesses outside of the property. Guess what? They were wrong.

There is nothing you can do internally that will change the perception of what is occuring outside your home. I don't care if you live in Buckingham Palace. If your home is located next to a toxic waste dump, buyers will be hesitant in even putting in a offer for your home.

Function obolescene is defined as the following:

Functional obsolescence (or superadequacy) is the loss in value (value measured as the cost to build) due to bad design.

One of the apartments I saw on a broker open house tour was this enormous one bedroom that was owned by an event planner. Like her job, she treated her home as an event with tacky decorations and a grand living room. What really stood out was the jacuzzi that was inserted placed in the middle of her bedroom. I guess she wanted to be able to slide from her bed into hot tub as soon as she woke up. But I wouldn't be surprised if she had fallen into the hot tub by accident in the middle of the night.

This was truly an act of bad design and I would not be surprised if she did not get her asking price since it would be at the buyer's expense to rip out the bot tub and replace it with a floor.

When you embark on the renovation journey, remember that what you are doing is not an exact science. You have to committ to an enormous amount of due diligence, because the process itself is quite expensive and time consuming.