Imagine you just finished up a sweet $40,000 kitchen remodel. The old cabinets from the 70s are gone, your green vinyl flooring has been replaced, and a thick granite slab and stainless steel appliances have trumped formica counters and crusty outdated appliances. You’re extremely happy, and also satisfied to have improved your property value by $40,000. That’s what you did, right? Not necessarily.
Why do appraisers not recognize the full cost? It can feel maddening to property owners when appraisers don’t include the full cost of a remodel in an appraisal report. But there is a reason why the total cost might now show up in the final value (assuming the appraiser did a good job of course). The key issue in the mind of an appraiser is how much buyers are willing to pay for the remodel. Or in appraiser lingo, what is the reaction in the market for the kitchen remodel? Through research and comparison to other properties in the neighborhood or market, appraisers find out how much a kitchen remodel is worth. For instance, if homes with an outdated kitchen are selling at $250,000, but homes with a similar kitchen remodel are selling at $270,000, then it’s clear the market is willing to pay $20,000 for the kitchen – despite the cost at $40,000. By the way, there is no universal figure or percentage for what buyers will pay for a kitchen remodel. The $20,000 I used is only an example.
Cost vs. Value: This scenario highlights that there can be a huge difference between cost and value. Cost is what we pay for something and value is what it’s worth. As much as we’d like to think these two are the same, that’s not always the case. It’s easy to see differences between cost and value when we consider things like extra square footage, built-in swimming pools or a very expensive remodel that definitely won’t see the cost recovered in the market because the house is now overbuilt. Experienced inventors know this phenomenon well too because they have to be very cautious about their numbers. They know an $80,000 remodel doesn’t necessarily add $80,000 in value to the acquisition price – especially if the initial purchase really wasn’t that good of a deal. That’s why the goal is to buy low enough to fit in the cost of improvements and profit. Ultimately no investor wants to make the wrong type of improvements or outspend the resale value.
If you’re concerned about resale value, it might be worth it to talk with an experienced Realtor or appraiser about your plans (before you remodel).
Questions: What do you think adds the most value to a home? What type of improvements would you recommend for home owners? Any stories to share if you’ve had your property recently appraised?
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Nice article on cost versus value. It has been my experience that cost and value definitely differ sometimes substantially. The best example (on the extreme end) I can give is a small rambler I was doing an appraisal inspection on. The exterior of the home looked like a typical 1970’s rambler, well kept, but typical. I walk through the front door to find the entire floor and walls of the interior covered with marble and not any big box marble either; marble imported from Greece. The homeowner told me how he had moved to the US from Greece a number of years ago and he had his family ship over the marble from their family marble excavating business. He stated he was pretty sure the added value to the home was in the 100’s of thousands of dollars as this was what he estimated it would have cost to buy and install it all by anyone else. I don’t doubt the cost he was estimating but my job as an appraiser was to find the value. In this case the extent of the marble likely detracted from the homes market appeal and in the the end my opinion of value was likely well below his cost estimate.
Thanks for the comment and fantastic example. It just shows there is a difference between personal preference and what is acceptable and valuable in the market. I have an appraisal in my bag right now that had an extensive kitchen remodel, and it’s not going to add anywhere near the cost. I think part of the trouble with kitchen remodels is that sometimes big companies charge an arm and a leg, whereas the owner could have found someone independent (and licensed of course) to do the job for significantly less.
I know its an older thread, but one thing that also should be considered in remodel is the value of the item being updated as-is. For example, if you paid $200,000 for a home with a dated kitchen, and spend $60,000 on an update, you need to consider the attributed value of what you took out.
For example. If you bought the house for $400,000 with a dated but functional kitchen, you bought it in livable condition. Would you have paid the same $400,000 for the home if the kitchen was gutted? Not likely. You may pay moderately or considerably less for the lack of a kitchen. If a home nearby sold with a gutted kitchen for $370,000, then you can surmise that the value of the existing kitchen to the transaction was $30,000.
In the current remodel scenario, the first thing you are doing is ripping out a feature that is worth $30k to the market, thereby reducing the immediate value of your home. By then putting in a $60k kitchen, you are not going to get a $60k increase, but may only see a $30k increase as the other $30k just reflects replacing the value of what was already there.
Its a simplistic example, and the numbers are not provable really, but it is a logical example that we can give to borrowers to foster understanding of why a remodel cost does not reflect fully in value increase.
That’s great, Michael. I appreciate your way of looking at it since it adds one more layer to the conversation. I hadn’t thought of communicating value that way before in terms of removal of the kitchen plus the remodel. Good stuff.