Over Improvements and Non Contributory Value

The principle of contribution states that the worth of an improvement is what it adds (or contributes) to the market value of the entire property, not what it cost to add the improvement. This is a key factor when deciding to add to existing improvements.

People who buy real estate often believe that if they spend money to add additional improvements to their property, the market value of their property will go up by the cost of the improvement they added on. For example, many people have added swimming pools to their homes or have remodeled their homes because they assume that these improvements will add significantly to the market value of their properties. This is not always the case.

Swimming pools are a common example. Having a pool could add between $5,000 and $10,000 to the value of a home, depending on size, location, design etc. Given that pools cost between $10,000 and $20,000 or more, people should build swimming pools because they like to go swimming, not because it is a wise investment to increase financial gain upon sale.

There are times when improvement can add more than its cost to the resale value of a property. Sometimes adding an additional room can be a very simple procedure (not always!), since when people search for homes the first thing they usually look at is the number of bedrooms and bathrooms.

It is the appraiser's job to be aware that there can be huge differences in the value of different improvements in different circumstances. A swimming pool in Las Vegas would be worth much more than a pool in Boston. Appraisers will need to run detailed comparisons of similar properties to determine how much value that improvement added. This is all the principle of contribution: how much does an item contribute to the value of the property?An over-improvement is an improvement that is larger or costlier than what is typical for the neighborhood. For example, a 4,000 square foot home located in an area of homes where the typical home is 2,000 square feet may be considered an over-improvement. Furthermore, a home with an in ground pool in an area where pools are not typical may also be considered an over-improvement. The appraiser must comment on over-improvements and indicate their contributory value in the Sales Comparison Approach adjustment grid.

Improvements can represent an over-improvement for the neighborhood, but still be within the neighborhood price range, such as a property with an in-ground swimming pool, a large addition, or an oversized garage in a market that does not demand these kinds of improvements.

The fact that the property is an over-improvement does not necessarily make the property ineligible. However, lenders must review appraisals on properties with over-improvements that may not be acceptable to the typical purchaser to ensure that only the contributory value of the over-improvement is reflected in the appraisal analysis.

Check out these few tips below on how to spend your renovation reserves wisely.

Extensions and Conversions

Who doesn’t want more space? Unless you are simply splitting a room, extensions can be one of the most costly renovations, as it involves creating new walls, foundation and roofing, and may also bring hefty building permit fees from your city or county government. Additionally, extensions not built correctly can affect the load-bearing weight of a roof and a home’s supporting structures.

Extensions and conversions must be compliant with local and state building code, fire safety, and exit egress. If any of these areas are problems in a future buyer’s appraisal, a sale will come to a screeching halt.  

Renovations That Are too Personalized

My husband and I learned about personalized renovations the hard way. We thought we’d created a beautiful accent wall when we repainted our living room. To us, we chose a lovely shade of what Home Depot called “Butternut” that reflected morning sunshine. Would-be buyers, however, saw a garish shade of yellow that reminded them of a school bus. We eventually had to repaint the entire wall to garner any offers.

If you are considering renovations, aim for timeless upgrades with a simple and clean design and a neutral color palette. Also remember, the latest contemporary “popular” design can quickly look dated in a few years, so choose textures and style carefully.

Renovations That Are Difficult to Replace, Repair or Duplicate

That special order, cut-glass kitchen backsplash might look beautiful against those rustic, reclaimed wood cabinets – but ask the question, “How easy would this be to replace if it gets damaged?”

As a military family, moving is pretty much guaranteed, but there’s also the risk of a short, no-notice PCS. If this home had to be rented out and tenants damaged the property, how easily could any custom renovations be repaired?

Eroding Equity

Costly upgrades can quickly erode any equity that had been building in a home. Remember, whenever you do decide to sell the home, at a minimum to break even, your sale price will need to be high enough to also cover real estate agent fees (an average of 6%) in addition to your share of any closing costs, which average 1-3% of sale price.  

Additionally, too much money sunk into renovations can leave you in a position to lose money if you try and sell too soon and force you to ride out the market, hoping for aggressive appreciation to recoup renovation costs.

Making Your Home the Most Expensive One on the Block

It may come as a surprise, but over-improving a home can actually make it harder to sell, especially if it’s the most expensive one on the block. A house that is priced too far above what other homes are selling for is going to be met with one question: “Why?” What is it about this home that has it priced above comparable homes?

If renovations out-price what the market will actually bear, the house will be difficult to sell at a price point to recoup money sunk into it. If a buyer is paying top dollar in comparison to other homes, where is their future appreciation going to come from? If no buyer can answer that question, a house is overpriced for its market and will not sell.  

If you are evaluating renovations, choose areas that historically provide a solid return, such as kitchen and bathroom updates. Aim for clean, simple design elements using construction methods and materials that can easily be replaced or duplicated if damaged.

One of the best things you can do before undertaking any renovation is to determine a home’s existing price point. What is the home currently worth on the market? You can get a ballpark estimate through real estate search engines, but a local real estate agent will be a more accurate in-the-know information source.

It costs nothing to ask what a home, either yours or one on the market, is worth. A little strategic thought can determine which renovations your family can both enjoy and recoup.