April 30, 2010

Remodel or Buy A Different House

My wife and myself have discussed doing various interior and exterior improvements to our home.   I bought our current home close to 11 years ago.   The house is big enough for my wife and myself and it has room to grow when we have children.   But the house is now 25 years old and the interior design and fixtures are starting to get dated.   (Remember the 80's?)   The kitchen and bathrooms could definitely use some updating.   Some of the other trim and fixtures in the home could be replaced as well to better suit our tastes. While our home is certainly livable as it is, improving the home is a priority for us over spending on things like new cars or expensive vacations.

We could do inexpensive improvements like repainting our kitchen cabinets and relatively cheaper floor options.  This would let us improve things for a reasonable expense.  But it would be surface improvements and still leave us with 25 year old drawers and hardware.   If we were on a tighter budget and wanted to make our home look nicer then this would be a good option.

If we want to stay in the home for a long time and want things to be nice then it would make sense to go ahead and spend the money up front and do a full remodel to give us the quality and style we want.  This would mean replacing kitchen cabinetry entirely and possibly knocking down a wall here and there.

This is what leads me to the question:   Should we spend the money to do complete remodeling or should we maybe just buy a completely different house that already has features to our liking?  

This was an interesting idea we came across and I'm not sure why we didn't think of this option before.  I'm going to examine it from at least a theoretical viewpoint.   I'm going to set aside the idea of saving money on remodeling in various ways like DIY and look at hiring professional contractors.  I also don't really know what remodeling would actually cost us so I'm just talking theoretical ballpark estimate at this point.   I also don't really know what kind of home we could buy that would have the features we'd want and what exactly it would cost.   A cursory look through homes for sale in our city on Realtor.com makes me think finding a home with the features we'd want wouldn't be very easy.   But I wanted to look at the idea of comparing the finances of major interior remodeling versus simply buying a different house as a concept.   It could turn out that remodeling is usually the best option or not. 

If we remodel the kitchen and both bathrooms then it could easily cost $20,000.   I'll go ahead and multiply that by 2 since I seem to underestimate home improvement projects by half so we might end up spending something like $40,000 to do all the remodeling we'd want.    The house is currently worth something around $210,000 to $220,000.   That would mean spending about 20% of the value of the home in remodeling the kitchen and bathrooms.   This is a very rough estimate without high accuracy.  I honestly don't know if fully remodeling would cost $20,000 or $60,000.   But I'm picking a number for estimating purposes.

When you remodel a house you don't retain 100% of the money you spent on remodeling in the value of the home.  If you remodel a house properly then you will see some of that money spent on improvements increase your equity but generally only a fraction.  Remodeling magazine does a cost versus value report on how much of your remodeling expenses you retain in home value.   Generally you're likely to see 70% of your remodeling spending retained in equity.     If I use that 70% number as a rough gauge then if we were to spend $40,000 on our home we'd retain about $28,000 of that in home value.   I could guesstimate that spending $40,000 in remodeling would raise the value of our home to something around $238,000 to $248,000.   The 70% figure is also a rough general estimate.   That return rate could vary considerably.

So lets look at theoretical comparison of two feasible options:

Option 1: Start with our home worth $220,000, a bankroll of $40,000 in cash and a $70,000 mortgage.  Spend $40,000 on remodeling.   Retain 70% of spending for $28,000 increase.  Home now worth  $248,000.   Equity of $178,000 and a mortgage of about $70,000

Option 2 : Start with our home worth $220,000, a bankroll of $40,000 in cash and a $70,000 mortgage.  Sell current home for $220,000 and pay Realtor 5% or $11,000 in commission and cash out equity of $139,000.  Leaving us now with $179,000 in cash.   Buy another home for $241,000 and pay closing costs of 3% or $7,200.  Take out a $70,000 mortgage.   We'd end up with equity of $171,000 and a mortgage of $70,000.

Looking at it this way, financially option 2 doesn't seem like a good idea at all.  Since you're having to pay the Realtor commission and the closing costs to buy the new home and finance a new loan that adds up to quite a bit of money.   But we've got some variables that are mostly guesswork.   If it costs $60,000 to remodel instead of $40,000 then that changes the picture.  If the remodeling cost is $40,000 but had a 50% return then the equity would be $170,000 at the end about the same as buying a different house.    On the other hand I don't know if I can get a house that has everything we want for $220,000.   Buying a different house that is in the condition and style we'd want for the right price might be hard.   There are a lot of unknown variables so how it works out exactly is very undetermined.

Option 1 has benefits of giving us exactly the stuff we want.  So if we want cherry wood cabinets in the kitchen and quartz counter tops then we can get that and get exactly the colors and options we want.   Option 1 has a lot of hassle involved in shopping for stuff, finding good contractors, getting quotes and getting the work done.   We also don't have the opportunity to find a bigger house or move to a better school district.

Option 2 has the benefit of possibly getting more for our money and completely avoiding hassle of remodeling work.   Option 2 has the downside of having to sell a home and buy another then move from our home to another house. 

Overall I think remodeling our home a bit is probably the better option financially assuming that is the only goal in mind.   It doesn't seem we'd be able to find another house with the features we want very easily and the transaction costs of selling our existing home and buying another home would not make that option very feasible.

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