My wife and I plan to embark on a terrible financial journey most commonly known as ‘a kitchen renovation.’
Launching ourselves into this journey reminds me of the excellent book by Jonathan Clements, a longtime Wall Street Journal columnist and author of the 1999 best-seller 25 Myths You’ve Got To Avoid If You Want to Manage Your Money Right.
You should read it.
Right there in black and white, under myth #19, Clements names the financial folly of what my wife and I plan to do.
Clements cites the home improvement industry literature that promotes this myth by bragging:
“You might recoup 95 percent of the cost of a minor kitchen remodeling, 91 percent of a bathroom addition, 83 percent of a family room addition, 77 percent of a bathroom remodeling, and 72 percent from adding on a deck.”
As Clements rightly points out, there’s a math trick embedded in that claim. Say you spend $10,000 on a kitchen renovation. When you recoup 95 percent of the cost of a kitchen in a sale, you are selling your house for $9,500 more than it would have sold pre-renovation.
In other words, you’re still losing $500, or 5 percent on your money. In pure financial terms, you’re just down 5 percent.
Not the mention the headache of having to pick out backsplash tiles and drawer pulls. 1
You wouldn’t hear most financial advisors claiming they did a great job on your deck renovation because “congratulations, I only lost 28 percent on your money!” And yet that’s what’s happened when you, as the home improvement industry claims, recoup “72 percent from adding on a deck.”
A positive investment?
Those are the honest(ish) numbers from the official home improvement industry, which acknowledge the financial loss, but spin it positively.
Much of the home improvement industry – from mom and pop hardware stores to store giants like The Home Despot, not to mention the real estate industry and the home equity loan industry – wants you to believe that spending money on a remodeled kitchen or bathroom or new deck or whatever is providing a great investment return.
“Think of the resale value!” your real estate agent crows. FYI, Your realty friend is actually more focused on her future 6% of the resale value, which will go up if you spend your money to remodel the kitchen.
“Wow, that granite countertop that you paid $3,000 for sure will make the house sell for at least $10,000 more!” encourages The Home Despot guy (who sells granite countertops for a living.)
“Even if you draw down $15,000 on your home equity line, you’re building equity because you’ll at least double that when it comes time to sell,” claims your home equity loan banker.
So lots of industry people are invested in this idea that home improvements ‘pay for themselves’ or even provide a positive return on your capital.
Sunny day? Let me introduce you to my wet blanket. I just don’t believe it.
Markets are efficient
I don’t believe it because markets are efficient. Even inefficient idiosyncratic real estate is more efficient than we realize.
Another way of saying that is it’s a mistake to assume prospective buyers of your house are dumb.
Buyers generally understand that a $3,000 Viking refrigerator isn’t a reason to pay $10,000 more for your house.
Despite what those ridiculous home improvement ‘reality’ shows claim, your $25,000 make-over isn’t going to induce buyers to pay an extra $75,000 for your house, because many many prospective buyers are just as happy to keep their $75,000 in their own bank account, and invest their own extra $25,000 after they buy your house. Most prospective real estate buyers can do the same math as you. Some even do math better than you!
Does it help at all?
I think home renovations can help in a limited way if you need to sell.
If you are in a hurry to sell, and your house has serious shoddiness issues, a spiffed up kitchen or bathroom could speed up the sale process. That makes sense because fewer buyers want to tackle renovation projects, so you can exchange your money upfront for a speedier sale, by appealing to the widest audience. Because markets are efficient I doubt the net price is actually higher (after adjusting for renovation costs), but you may have spent less time to locate the willing buyer.
So why do this?
If I’m not making money on the kitchen renovation, why do it?
When I run the toaster and microwave simultaneously, I would prefer not to trip the breaker every single time, shutting down all my lights on the first floor. How dare I both toast and heat something at the same time?
When I chop carrots at the same time that my wife measures the rice, we’d prefer not to inadvertently elbow each other in the gut (repeatedly!) because we have less available counter space than a regulation chess board. 2
We open the door to the dishwasher but it boxes us out of the only available cabinet for glasses. I end up on tippy-toes, reaching past the dishwasher door, like a forward getting pushed out of the paint by Tim Duncan stretching for the rebound. The cabinet is so far away, and so awkward to reach.
And I’m sick of all that.
The kitchen renovation may be a terrible financial journey, but I’m ready to spend some money on living better. And that’s not a bad choice. It’s just not the money guy choice.
Let the demolition begin.
A version of this post ran in the San Antonio Express News.
See related posts:
Book Review: 25 Myths You’ve Got To Avoid If You Want To Manage Your Money Right by Jonathan Clements.
Ask an Ex-Banker – Home Equity Loans and Home Equity Lines of Credit
Judgment vs Objectivity – My Recent Home Equity Line of Credit Renewal
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