We are doing a major home renovation this Winter. It should provide fodder for several blog posts over the next year (possibly including one from my contractor) and lots of fun pictures for the blog. This first post will be a pretty general introduction to the financial aspects of home renovations, but future posts will get into all kinds of details. Let's outline a few principles to keep in mind if you are considering a home renovation.
#1 Housing Is Mostly a Consumption Item
A house is an investment that can go up in value and “pays dividends” in the form of saved rental payments. It is often leveraged, and the mortgage introduces a completely separate financial instrument. Paying down a mortgage is often one of your best guaranteed return investments as a mortgage functions as a negative bond. However, many aspects of your house are really consumption items. They are simply items you are using up in living your life.
It's fine to consume stuff; you don't need to feel guilty about it. In fact, I have a hobby that is all about consumption. Due to the friction inherent in the passage through slot canyons, every piece of gear you take in there is disposable. Your boots and pack are good for about a season, you replace your gloves every couple of canyons, knee pads last a week (two if you cover them in roofing sealant) you might get two years out of a harness etc. Your house is the same way. That toilet, paint, carpet, and windows are being slowly used up. If you spend too much of your income on stuff going down in value, you're never going to build wealth.
#2 You Don't Increase the Value of the Home by the Cost of the Renovation
A lot of people mistakenly think they'll get the cost of the renovation back out of the house when they sell. That is never the case.
First, even if you sold the house right after you renovate, you never get 100 cents back on the dollar. It varies by the upgrade, but it generally looks something like this:
- Minor bath remodel: 102%
- Landscaping: 100%
- Minor kitchen remodel: 99%
- Exterior improvements: 96%
- Attic bedroom conversion: 94%
- Major bath remodel: 93%
- Major kitchen remodel: 91%
- Basement remodel: 90%
- Windows: 90%
- Family room addition: 83%
- Bonus room updates: 73%
- Living room updates (decor): 66%
- Bedroom updates: 52%
- Living room updates (walls and floors): 40%
However, these estimates can have a HUGE range. For instance, some sources say a major kitchen remodel really only has a return on investment of 54%. “Invisible” improvements like replacing the A/C and water heater are even worse. They return almost no value, it's just a major problem trying to sell if they're broken. A roof is similar. Buyers just expect the roof to not leak. You don't get any credit for replacing it last year versus ten years ago.
In addition, what your neighbors are doing can have a huge influence, too. Bringing your home up to par with the neighborhood has a higher return on investment than making your home the nicest one in the neighborhood. At any rate, the point is that some percentage of the renovation increases the value of the home. The rest is just consumption. Thus, a renovation is almost never a good investment unless it must be done in order to sell the house, and even then it probably has a negative return on investment.
Second, as soon as you renovate, the new stuff starts dropping in value. That 66% return on investment for updating your living room decor is on day one. Two years later it might be 30%.
#3 Renovation Is Usually Optional
It was interesting to sit down with our friend the general contractor (Stevens General Contractors) to discuss this project. The first question was, “What are your needs?” Wrong question to ask The White Coat Investor. I quickly clarified that NONE of this was a need. This is a house that had empty rooms for the first two years we owned it. It still meets all of our personal and business needs. We can continue to run this multi-million dollar business off the dining room table and a downstairs bedroom as we have for the last eight years.
There is no requirement that you furnish every room in your house as soon as you buy it. Nor is there a requirement to do a renovation. Pretty much ever.
#4 Renovation Is a Hassle
This was actually the biggest argument for me against doing a renovation. You have three choices.
You can do the work yourself. This sucks because it is time you could have used to generate income with your main work or side gig or better yet, time you could have spent doing something you enjoy. Plus, you'll probably do a crappy job of it because this isn't your life's work.
You can live in a house where worker dudes show up every morning at 7 or 8 and leave at 5 or 6 every evening, dealing with the noise, intrusion of privacy, security issues, loss of use of some of your space, and hassle of moving stuff around as the workers go from one area to another. My contractor tells me they do most kitchen renovations in the summer, moving the fridge and microwave into the garage and the family does a lot of grilling on the back deck and eating out.
You can move out. Nobody likes moving. It takes a lot of time and a lot of effort. Plus, you're now paying for two houses during the renovation. Plus, most renovations last less than a year and most rental contracts are a year-long, leaving limited options. One benefit of moving, as military folks know, is its anti-hoarding effect. It's a lot easier to throw stuff away if you have to actually box it up and carry it around. Plus, a big renovation usually gets you a big dumpster in your driveway for maximum decluttering ease.
#5 Everybody Has to Get Something
Due to the massive cost and hassle of doing this, everybody in the family has to get something they want out of it. The impetus behind the remodel is to redo the kitchen. When we moved in back in 2010, Katie said the kitchen would do for now but she wanted more storage in it and more space. “Fine,” I said. “We'll do it when we can afford it.” Well, there's no doubt we can now afford it. So here we go. But renovations usually become linked.
“Well, if we're going to do that, let's do this too.”
It's usually cheaper to do it all at once rather than piecemeal, as it offers a lot of economies of scale. It's cheaper to paint three rooms all at once than one room at a time each year. For instance, we've done some work over the last few years — wood floors, garage doors, a new door, and some new windows. Unfortunately, pretty much all of that will be ripped out during this renovation. It is best to know what the end product looks like before you begin if you want to do it as inexpensively as possible.
In this renovation, we all get something. Katie gets her new kitchen, a big pantry, and a nicer bath. I get a much larger garage and a larger yard without my current landscaping problems. WCI gets dedicated office space and a sound-proofed recording studio. The kids get a slide, a fire pole, a game room, a toy room, and a nice theatre room. The extended family gets that other guest room (currently a makeshift podcasting studio) back. My contractor says this is the way it usually goes and he is often surprised to see what the item is that finally gets the most reticent member of the family on board. The firepole is clearly what tipped it over the edge for me and the rest of the kids.
Our process started nearly a year ago, just with some dreaming and scheming and discussion. Our general contractor is a good friend. Not the cheapest guy in town, but I know where he lives so at least I know he's not going to take the money and run. The first time we actually put down money and committed to some dates on the schedule was in March, when we forked out $5K for plans.
Interestingly, the architect is actually the original architect for the house, so that made things a bit easier. Every couple of weeks the contractor and the architect come over with a new set of drawings and we tell them what we like and don't like. They tell us what's possible. And we send them back to the drawing board. There is usually a problem area that takes the most work. In our case, it was access to the new office space, but after four iterations, we found something that would work.
In July, we met with the contractor again about pricing. This wasn't a complete mystery, as I had been asking for general estimates as we went along. So while I had sticker shock several times already, most of it has worn off, although it still seems a ridiculous sum to someone who was donating plasma for food in college. The pricing process is also eased by the fact that a large portion of our remodel is similar to our contractor's house down the street. He knows exactly what he paid and so can estimate his costs pretty effectively. Once we knew the range of price we're looking at, we could decide if we wanted to scale back the project to save money.
We didn't actually set a budget for this. Our only goal was to cash flow it. We didn't want to borrow any money and we didn't want to have to raid investments for it. So after maxing out the Roth IRAs, HSAs, 401(k)s, and DB/CB Plan for the year and putting in the tax-advantaged amount into 529s (as well as a couple of taxable investments) we stopped investing in about May and started piling up money. We paid our taxes a little ahead, got a little ahead on our usual charitable contributions, stopped saving for vacations and directed every spare dollar into the renovation fund. By the time we moved out and broke ground in October, we had almost all of the cost sitting in cash in a money market fund. The rest will be easily saved during the 4-6 months the renovation will take. Although we'll make some large payments as we go along, the largest payments are backloaded, as they should be.
Financially speaking, doing a renovation at this point in our lives is pretty easy. We don't have any debt. We're financially independent (i.e. essentially done saving for retirement). Our kids' college funds are already beyond their initial goal and well on track for the new, higher goal. We've already bought the luxury outdoor equipment, toys, and trips we really wanted. We're giving away more and more money to charity every year. Our income continues to rise and we've basically run out of other financial goals. So, while completely optional, it seems reasonable to spend some money (okay, A LOT of money) on the last thing we can think of that could possibly make us any happier.
The renovation will cost more than we paid for our house. More than it is currently worth. In fact, more than twice what we paid for it originally. That's what happens when you redesign your entire lot, remove every piece of landscaping, do work on all four walls of the home and the roof, add a fair amount of square footage, move a bunch of walls around, and basically make everything two steps nicer than it was originally.
Will it be worth it? I figure about 2/3 of it will come back to us in increased value of the home. The rest will just be consumed. We can certainly afford to consume that portion. The marginal utility of additional wealth has steadily dropped for us over the years. That's the way it usually goes — you end up having to spend more and more money to get the same amount of increased happiness from doing so. But if you can afford it, you want it, and you can meet all your other financial goals in spite of it, why not? I think at this point we're far more likely to regret not doing it than doing it, so here we go!
Some Home Renovation Advice for You
Now, we're a bit of an unusual example, even among high-income professionals. Not counting major home renovations, we're living on less than 10% of our income and give away more than that each year. I don't think you have to be in our situation before you can renovate your home. But I think there are a few guidelines you should follow:
- No renovations while you have consumer debt or student loans. You've got better uses for your money.
- No renovations while you have a mortgage > 2X gross income. You're already house poor, don't make it worse.
- Cash flow at least the amount that the renovation won't increase the value of the home. For us, I figure that's about 1/3 of the cost. I don't think it's the end of the world to borrow the rest, as long as it doesn't take you over the mortgage < 2X gross income figure. Saving money is good for you. If you can't save up 1/3 of the amount of the renovation in a year or two, you are probably doing too much.
- No renovations if it will significantly slow you from meeting your reasonable financial goals. If this pushes retirement back a decade, that probably isn't worth it.
- Think long term. We've had other houses that we upgraded just in time to move out of it. You're much better off enjoying your renovations for a while, especially since you never get 100% of the cost out of it when you sell. I told Katie we're not doing anything to the house for a decade afterward, so we need to be thinking about anything else we might want and do it now. We're also configuring the house to allow us to stay in it long-term. We might be 40-something and healthy now, but there's no guarantee that we can climb stairs in a decade or two. The firepole is easily convertible to an elevator. The WCI office space is easily convertible into an accessory dwelling unit (immediately for someone we're willing to share living space with, but a separate entrance would need to be constructed to make it a great ski rental.)
[Update Prior to Publication: Since this was written months ago and its publication today, we've moved out, the project has started, the house has been demolished and lots of decisions have been made. But I'm not going to talk about all that today or in the comments on this post lest I have nothing else to write about it! More details in posts to come.]
What do you think? Have you done a major remodel? What did you like and dislike about the project? Any tips for us and others? Comment below!