Every once in a while, I’ll catch one of those real estate/home decorating/home improvement programs on HGTV, TLC, A&E, or whatever channels you find shows like Designed to Sell. Sometimes, the “experts” repeat adages which simply don’t make any sense to me. I believe that these statements were probably true (conditionally) at one point in time, but I don’t think they hold water any longer, because they were never sustainable as a result of their reliance on continuing inflation.
In one instance, they updated a bathroom to the tune of about $5,000, at which point the designer and the real estate expert told the sellers that the renovation could add $20,000 to the price of the house.
That’s a 400% return! Does anyone else think that’s crazy?
We can clearly see that the prices paid for the renovations have been affected by competition, otherwise, the price of renovation could approach the value-add. But it doesn’t, instead the price of renovation approaches its opportunity cost. That is, competition among renovation providers has eroded the price each one is able to command. Shouldn’t competition among sellers have a similar effect? Why are home buyers seen as price-takers?
If it is true that a 400% return can be made on a bathroom remodel, then everyone with a modicum of financial wherewithal will remodel their bathrooms, and price competition among the sellers should tend to drive that return down to a normal rate of return as constrained by time preferences. There’s no reason that anyone should pay $20,000 for a bathroom they could buy themselves for $5,000!
Well, there is one reason: inflation! When buyers had access to excessively loose credit, and they believed that prices would continue to rise (at an unsustainable pace), they gladly overpaid under the assumption that someone else would overpay even more in the future!. Most of these people probably had no idea they were overpaying, to begin with!
Sure, there are factors at work that probably can’t be arbitraged away. An updated room is aesthetically more appealing than a run-down or simply outdated room. This alone should command a premium over the un-updated house. There is a certain amount of risk that the remodeler will go over budget, or run into problems along the way. Buyers would be wise to pay slightly more for the certainty of a job completed, than to bear the uncertainty of renovation on their own. There is also a price one must put on the inconvenience of living in the house during the reconstruction. We could expect buyers to pay extra for the privilege of not having to deal with this, too.
I’m not convinced that these factors can justify the batshit-insane returns that sellers are told to expect, but I’d be happy to field your thoughts on the matter.