Should we add a bedroom or a bathroom? How about finishing out the basement? A garage apartment would be a nice separate space for visiting friends and family….
Chances are, if you’ve considered adding-on or remodeling your existing home you’ve had similar thoughts and questions. But how do we improve our home and simultaneously give ourselves the best chance for a positive return on investment?
Real estate is a fickle market, and a notoriously imperfect one: humans are prone to irrational decision making, and this conundrum is compounded when dealing with an emotional topic such as one’s home. What follows is a brief overview of potential value adding improvements from the perspective of a valuation expert.
Perhaps the most important principle at the forefront of property improvement is a rather inconvenient truth: cost rarely equals value. The dollar amount you allocate to an improvement almost never equates to the contributory value added (or lost). A common example is the addition of a swimming pool. The average cost of an in-ground pool hovers around $35,000, however the pure value added to the total market value of the property might be $10k-$15 less than the cost of the pool. One need not be a mathematician to conclude that in the purely financial sense this is a poor investment. There are several additions/modifications that can prove to add value to your home at a greater rate than cost, however they must adhere to certain criteria when considered in the valuation of a home.
Real vs Personal Property
To be considered in the valuation of real estate, any improvement on a property must be a permanent fixture to the real estate itself. Is it owned or leased? Is it permanent or non-permanent? An example might be a detached workshop on a block and beam foundation. While it may appear permanent, a forklift and the disconnection of a few wires renders it mobile rather quickly. Solar panels may improve your home’s efficiency, but if they’re leased rather than owned the question of whether or not they add value to a prospective buyer or lender is a moot point: because they are not explicitly owned, they are not considered real property and thus not taken into account when valuing the property.
The Market Calls the Shots (“It depends…”)
In the residential real estate valuation process, the most widely used method is the Sales Comparison Approach. Purely market based, this is the foundation for the real estate professional’s comparative market analysis (CMA), and should be at the forefront of any decision making process. If the perceived value added cannot be proven in the local market, then it is difficult to give it a dollar amount in the valuation process. Local market is emphasized here because all markets are different: an additional bathroom might add $10k to one home and be a complete non-factor in a competing market (it depends!). That additional bathroom must be proven to add value within the market by comparing two otherwise similar homes: all other things constant, the difference in sales price between a two bath and three bath home is the added value.
If you are planning an addition to your home there are several considerations to keep in mind, chief among these being the effect on gross living area (or GLA). GLA is the valuation synonym to finished square footage (with a few notable exceptions), and deals with the amount of space, above grade, within the primary dwelling. If you are looking to add value to your home this is a very effective tool, however it must satisfy several criteria in order to be considered GLA within the valuation process.
- It must be attached and immediately accessible via the main dwelling – a garage apartment or detached quarters does not contribute to GLA; you may decide that a detached living space is ideal for visiting guests, just be aware this area will not be counted as GLA and the return on investment will reflect accordingly
- It must conform to the remainder of the dwelling – i.e. similar flooring and finishes; heating and cooling (if applicable) should likewise conform
- Basements are not considered GLA, though in some cases can add equal value to a GLA addition – an example would be a walkout basement with similar finishes to the above grade dwelling
Speaking of basements….
In the example above we considered a walkout basement with similar finishes to the main dwelling. These are fairly common here in the Yampa Valley as many homes are built into the hillside and thus a basement might have doors, windows, and generally conform with the remainder of the dwelling. It is not uncommon for these types of basements to be valued at the same rate as the GLA of the main dwelling, however they must have similar finishes when compared with the above grade living area.
An important distinction from the walkout basement is the interior basement. Fully below grade, these may have a window or two but otherwise low natural light penetration. They don’t typically have a natural “flow” with the rest of the home, and are often valued at a different rate than GLA and walk out basements. Keep that in mind when considering your finish level to an interior basement. While they can be an excellent spot to house visiting family or a mancave for the Broncos game, chances are the loan officer has never had your mother’s peach cobbler, and shocking though it may be there’s an underwriter out there who’s never heard of Von Miller. Cost will rarely reflect value in this case.
Minor improvements that could have a major effect on value….
An addition or a finished basement might not be in your budget, however there are plenty of options to add value without breaking the bank. Sometimes merely swapping out your kitchen counters, appliances and cabinetry for more modern versions can easily tip the scales in your favor. Updated bath vanities and hardware can substantially improve the aesthetic of a home to a prospective buyer at a fairly minimal cost.
So… what option is best for my home in my neighborhood?
You’ve made the decision to add to or modify your home, but what is the best course of action if ROI is the driving factor? A rather complicated question has an ironically simple answer: talk to your realtor! Realtors make their living by keeping a pulse on the market, and their commissions are reflected accordingly. It’s in their best interest to help you maximize your ROI and they are typically the best resource when tackling the project. If you don’t have a realtor, the Steamboat Springs Board of Realtors is an excellent place to start.
Just remember an improvement is an investment, and investments are rarely without risk. Your goal is to mitigate that risk as much as possible, and knowledge of the local market is the first step.
Robert “Dos” Crow is the President of Vanguard Valuation Services, based in Steamboat Springs