The Town Broker

Buying Your Westfield Home: The Cost Of Renovation

When I’m working with buyers looking for a home in Westfield (or any town with traditional older homes) it’s common to discuss a big decision: Should they buy a more expensive home that is “turn-key ready”, or buy cheaper and then do the renovation themselves?

I had the opportunity to spend some time this weekend with some Westfield buyers facing just that dilemma. Fortunately, they had the resources to do either one. So how should a buyer approach this decision?

Calculating The Renovation Cost and The Time Value Of Money.

It’s important to begin this discussion by acknowledging that there are a LOT of factors that come into play when selecting the perfect home. Location… including the quality of the neighborhood, schools and commuting distance to work are among the most important. This post assumes that everything else is equal, and that the buyer is deciding whether to buy a more expensive ”turn- key ready” home in the neighborhood, or one that needs major upgrading. It also assumes that the buyer has the finances and resources to do this without relying on some crazy exotic mortgage product to do it.

If you read this blog frequently, you know how I feel about people getting over extended!

In order for my buyers to consider the older Westfield home, they would want to do these 2 common home renovation projects: 1) a two-story addition, 2) a major kitchen remodel. According to Remodeling Magazine’s 2009/10 Cost vs. Value Report, the cost of these jobs done at the “mid-range project level” in the NY metro area is as follows:

1. Two-story Addition – $201,780
2. Major Kitchen Remodel – $69,069

The total for this work is $270,849 …hardly small change! But if they could save enough on the purchase of the older Westfield home, it might be worth it, right? Maybe.

Let’s assume for a moment that since we’re EXCELLENT negotiators (smile) we were able to get the older home for a full $350K LESS than the renovated home in the same Westfield neighborhood. Looking at these numbers, the cost of the renovation seems to pay for itself, right? Maybe…and maybe not. Here’s why:

It’s all about LEVERAGE

Real estate is one of the most leveraged purchases you can make. That is…most buyers use very little of their own money to secure the deal. They put up a down payment (we’ll assume 20% for this post), and use the bank’s money to leverage the rest.

And leverage can be very helpful when paying for home renovation.

According to Bankrate.com at the time of this writing, a 30-year fixed mortgage is going for 4.59%/ year. And according to their mortgage calculator, if you were to finance the full $350K for the “already renovated home”, it would cost you an additional $1792/month for the principal and interest.

If you started the remodeling of the older home on the day you moved in, how long do you think it would take to complete? Let’s say it took 1 full year. According to the numbers above, you’ll need to pull $270,849 out of your personal investments within 1 year to pay the contractor. The fully remodeled home would have only cost you an additional $21,504 over that same year ($1792 x 12 months).

In fact, at $1792/ month it would take 151 months… 12 years and 7 months…before you spend the $270K you forked over in year 1 of the remodel.

A buyer needs to consider how long they’re planning on staying in this house. The average American moves every 7- 10 years (although I’m beginning to see these numbers increase in our area). So in this example, if you financed the renovation and planned to move before year 12, you came out ahead (at least on the ledger).

The good news for the re-modeler is that you get to make the home your own. You can do the job the way YOU want to. But the bad news is that you have to tie up a lot of money to do it. A lot of your “liquid assets” will be converted into home equity… a very “illiquid” asset at best.

By leveraging these remodeling  jobs your money could be used in other ways during this time (college costs come to mind).

Now I know that there will be those who criticize this post saying “hey… he’s in a commission based sales business. Of course he’ll advocate for the more expensive house!” That’s a fair criticism. And my builder friends…many who are already struggling in this economy… might be really angry after reading this!  I hope not.

My purpose here is not to advocate one option over the other. It IS to encourage people to think past the dollar figures and think of renovation costs in terms of “money spent” vs. “money leveraged”.

Deciding which option is best for you depends on your specific situation.

This entry was posted on Monday, July 19th, 2010 at 3:20 pm and is filed under Buyers, Real Estate 101, Westfield. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.

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