The Art of Perceived Returns

📸 Photo by Daniel Lunghi

How to calculate if a construction project can improve (or hurt) your life.

Perhaps, when you first moved into your home, you promised your partner that you would remodel the kitchen.  Or maybe you’re feeling cramped or isolated in your current space: the point is, you want to make a change to your home and have a pretty clear idea of what it is that you want. But is it worth it?  

While we are all familiar with calculating financial returns on investment, when it comes to a home renovation project, there is also the far more subjective category of perceived returns. Calculating this is more of an art than a science. To show you what I mean, let’s first discuss the types of return on investment that you can expect from a home renovation project. 

Understanding Home Renovation Returns On Investment

The first type of return on investment is a cash return. As an example, imagine building an ADU on your property in Midtown Sacramento and that you rent it out to a traveling nurse. You make cash each month in the form of rent. There’s not much art here, admittedly. But calculating returns is not just about the cash in hand.

For example, the second type of return is appreciation. Using the same scenario as above, let’s say you build an ADU on your property: now other people think your home is worth more as its value has appreciated. If you continue owning the property for a long term it will likely gain even more appreciation since real estate in Sacramento generally goes up in value over time. If you are focused on making your property more valuable in this way, consulting a local real estate agent is a great idea as they will understand the types of properties and the improvements that people want in your neighborhood. But how much value does this project actually add to your life? Unlike the cut-and-dry figure from a cash return, projected appreciation is always in flux. 

Which brings us to the most subjective type of return: amortized. In this type of return the property value goes up as experienced by you and/or your family members. Using the ADU example again, let’s say you build an ADU in Midtown and your aging parent moves in. While you are not specifically collecting rent in this example, you now may have free childcare, or just the value of having a loved one nearby. It’s harder to quantify, because it’s relative to your specific situation. However, just because it’s not valuable to anyone else does not mean it’s not highly valuable to you. 

When I was 17 or 18, my parents decided to sell the home where we lived. They immediately completed all outstanding repairs, remodeled the bathroom, and listed the house for sale. It always struck me as being profoundly unfair—if my parents were going to spend the money to remodel eventually anyway, why did they do it at the very end of our time at that specific home? We did not get to enjoy the new bathroom at all. I did not know it at the time, but I was in the process of discovering that my family had been excluded from enjoying any amortized return on the improvement. (Now, after having kids of my own, I understand that they likely did it this way because they thought my brother and I would destroy their hard work). 

I mention this because a rough way to calculate the amortized project cost to you is taking the project cost and dividing it by the amount of time you intend to live in that home. Projected appreciation could be a bonus, but really the key here is to make sure that the project will first create value for you and your family.

The last type of return is not actually a return, but loss prevention (also known as maintenance). To prevent the ongoing entropy that is owning and residing in a structure built by humans, you must invest continually in dealing with issues and preventing new ones from arising. Anyone ignoring this expense will have a difficult time getting any type of appreciation on their asset.  

Should you renovate?

So now that you understand the ways that a renovation project might be beneficial to you, should you actually proceed with the project you are planning?

Let’s start with the easiest return to calculate, which falls in the maintenance category. If you need to fix a problem, do it ASAP.  For many people, their home is their most valuable asset, and a leaky roof and the damage caused by not completing that repair can be huge. Preventing a potentially significant loss is the best return on your investment that you can achieve.

The next most important return on investment is within the amortized category: the time of use. If you suspect that you will eventually undertake a renovation project on your home, given no other constraints, it’s best to complete it as soon as possible. The reason for this is that you will get the most amount of use out of the project possible: every month earlier that you complete the project will create another month of value for you while the cost of the project remains about the same. The offsetting functions here are that you can only realistically do what you can comfortably afford, and that the future is unknown.  While it’s best to do as big of a project that you can and make your time in your home the very best, taking on too large (and therefore expensive) of a project can create stress which can offset any improved quality of life that a remodel creates.

Lastly, we should consider the cash on cash return scenario. If you have finances that are not otherwise being used, investing in a project that can make you some money is a good idea. However, while we calculated the amortized value of a project in terms of life improvement, it’s important to consider the potential downside.  If you choose to add an ADU in your yard and rent it out to the traveling nurse, how much more complex might that make your life? What if the nurse stops traveling and starts having loud parties every weekend? Is it worth the trade off? While the amount earned is a hard science, calculating potential future disturbances to your life is an art.

At the end of the day we claim to be rational people, but the overwhelming evidence is that we make choices emotionally. Calculating how much better a new kitchen or master bedroom might make your life can really only be achieved by having thoughtful discussions with your loved ones. Whatever the decision process may be, at Lee & Co we have helped many people make the right decision for their situation, and we would be happy to discuss your plans and dreams with you to help calculate what your perceived remodel returns could be.