4 temptations to avoid when it comes to cost vs value in real estate

If you spent $50,000 on a 15 ft statue of Yoda in your front yard, do you think you’d get $50,000 back in value? A Star Wars fan might wet his pants and quickly offer a premium for the house, yet what would everyone else pay? That is the bigger question. We all know there is a difference between cost and value. Cost is the price of something, while value is what it is actually worth. We understand this logically, yet there often seems to be a disconnect between cost and value in the actual real estate market, which is why this conversation is important. Let’s look at some temptations to avoid as well as tips to get the most value out of improvements. I’d love to hear your take in the comments below.

cost vs value in real estate - by sacramento appraisal blog

Temptations to avoid when it comes to cost vs value:

  1. Treating Cost & Value the Same: Value can be much different from cost, right? This means a $47,000 home remodel might not lead to $47,000 in value. Or $75,000 in extensive landscaping might not command a $75,000 price premium. Or a $150,000 accessory dwelling built in the backyard may not automatically boost value by $150,000. Or a built-in pool that cost $35,000 to install may not lead to…. you get the point. We can always consider the cost and quality of something when we are trying to come up with a value, but at the end of the day we have to answer this question: How much are buyers actually wiling to pay for it? An owner might say, “I spent $136,000 on this rehab, and the appraisal came in low”, but if the appraiser used solid comps and made proper adjustments, the real issue could be the full cost of the rehab is not showing up dollar for dollar in the resale market (it’s actually not as easy as you’d think to get dollar for dollar).
  2. Letting Emotion Trump Data: What are homes actually selling for in the neighborhood? We have to look at sales to inform us about the resale market since sales help tell the story of what the market has been willing to pay. This is especially true when considering the ARV (after repair value) of a house that is going to be flipped (or even remodeled). It’s far too easy to get trapped into a formula like this: cost of acquisition + cost of remodeling + profit = value. But the truth is we need to look at the resale market first. What are remodeled properties actually selling for in the neighborhood? Once we have a good sense of the numbers we can then take steps back to determine if the acquisition cost and/or a rehab costs make sense or not. Thus an investor might pass on a house because the deal doesn’t make financial sense, or an owner might decide to scale back that extensive remodel.
  3. image bought and used with permission by 123rf dot com smDistracted by Shiny Objects: It’s easy to feel so excited about putting in the latest upgrades, that we actually miss value. In other words, we can get distracted by the glow of the new shiny features that we fail to ask whether buyers are going to pay for those features or not. For instance, someone might install $70,000 worth of energy-efficient features, but will buyers pay for that in the resale market?
  4. Projecting Other Neighborhoods on Yours:Β  What works well in one neighborhood may not work in a different area, so it’s important to not project one neighborhood on another. For instance, I appraised a house in a first-time buyer neighborhood that had VERY extensive upgrades. The owner had it listed over 25% higher than even the highest competitive sale so he could recoup his costs (it was way overpriced). The unfortunate reality here was instead of letting other remodeled homes in the neighborhood guide the owner on what type of upgrades to select, the owner instead put the best stuff from the region into this one house.

Tips for getting the most value out of upgrading your home:

  1. Buyer Expectations: Be in tune with what buyers expect in the neighborhood for upgrades. What are they actually willing to pay for? One way to know this is to visit open houses and talk with neighbors so you can see what others have done (and then see if their homes are commanding higher prices).
  2. Let Neighbors Overbuild: Don’t do more than others have done in the neighborhood. It’s far better to benefit from upgraded homes around you rather than be that one over-the-top property.
  3. Know your Location: Be realistic about your neighborhood so you are doing the right upgrades for the location.
  4. Consult a Professional: Talk with a reputable real estate agent or consult with an appraiser before you remodel so you get a better idea of where your dollars might be best spent to maximize value and appeal. This step is often not considered, but if you’re spending tens of thousands or hundreds of thousands of dollars, why not reach out to the real estate community before you break ground?

NOTE: Homes are not just about resale value. Owners should do what they want to their homes and enjoy them. But if you do plan on selling, maybe keep these things in mind.

I hope this was helpful.

Questions: Would you pay more for a Yoda statue in your front yard? What is Temptation #5 or Tip #5?

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Comments

  1. says

    Did you think I wasn’t going to read your blog post about my giant Yoda? Ever since I put up the statue, I’ve had random passers knocking on my door offering to buy my house. It’s cool, we can still be friends. I know that the value the statue returns to my house is far more than the $500k it cost me to have it custom built and air lifted from Frisco.

  2. says

    An appraisal to determine an “after improvements” value is one of the most under utilized resources available to homeowners. The value of this type of appraisal far outweighs the cost since it could save you thousands in over improvement costs. Thanks for reminding us of the important relationship between cost and value.

  3. Tracy says

    Considering that as I sit here reading this Luke my 4 year old is trying to explain to me the difference between a TIE fighter and a TIE advanced yes, we would pay more for a Yoda statue. πŸ˜‰

  4. says

    Excellent post Ryan, thank you!!! It’s just what I needed to read!

    I recently submitted an offer ($250k) on a house to flip. All of the comps tell me I can only ask an ARV of $310k-$335k… except for one stand-out comp that sold for $440k!

    I do the same kind of remodel as the guy that got $440k, but I think I can reasonably sell it for $360k-$375k.

    Can I use this stand-out comp if my remodel is the same in the same neighborhood?

    • says

      Hi Bev. I’m so glad this was useful. Thanks for the comment. I guess the question we have to ask is whether the $440K sale is truly a “comp” or not. Why did this one close higher than anything else? Does this one represent the market is it a “lone ranger” so to speak? Was it a cash purchase that did not require a loan? Did the seller kick back funds or property if the buyer purchased at that level? One sale does not make or break the market. In short, if this one sale is an outlier and does not represent the market in the neighborhood, it’s not the best idea for appraisers to use that sale unless there was a significant downward adjustment. If all other listings and sales are hovering between $310-335K, it sounds like your market is closer to that level. Now if other sales start closing at that higher level and/or everything is pending at 400K+, maybe there is a market at that higher range. I would look very carefully and try to understand the story of how that one sold so high. Is it the market or something else? It’s critical to understand that. I would also recommend paying attention to days on market for the recent flips. Are they going very quickly at $335K or are they beginning to sit on the market?

      • says

        Thanks for the reply Ryan! This rehabber is consistently getting $100k more for his flips than the rest of us. He has 5 or 6 of them now in this particular area… with that any are they still considered “Stand alone” comps? He’s also a contractor so he’s able to add square footage and special features cheaper than the rest of us. I’ll check to see if buyers are paying cash for his properties, thank you for the suggestion! πŸ˜‰

        • says

          Hi Bev, it’s still a puzzle how the investor could be getting that much more if the homes are generally the same size, in the same neighborhood, and have the same quality. I would still wonder if these higher sales are indicative of the market or if there is something funky going on. I get it if there is a quality, size, or location difference, but otherwise it’s a wonder if all else is the same. I do recall seeing one local investor who was getting way more than anyone else. The quality was fairly similar to be honest, but maybe the price boost had to do with the lending side of things. When an investor steers buyers to a preferred lender, it can result in inflated prices at times. Maybe the lender is using really aggressive appraisers, overlooking some things, etc… Who knows. πŸ™‚

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