Home Improvement Crisis Looming

In recent years, it seemed that you just couldn’t go wrong when improving your home. No matter what renovations were undertaken, or how much was spent, the property ended up being worth more than the original cost plus the cost of improvements.

In fact, many people have been making a living from flipping houses – buying a property, doing a quick make-over, and on-selling for a profit.

On paper, just about every renovation has seemed to be profitable. And yet the reality is that many home improvements are a financial disaster without people realising it. How can this be?

The answer lies in the steadily improving market prices of most properties, particularly those in sought-after areas such as California USA and Queensland Australia. A rising market will tend to hide poor home improvement decisions.

Let’s take an example. Imagine a house bought in 2004 for $400,000. During 2005, $60,000 is spent on improvements, and in early 2006 the property is sold for $500,000. Leaving aside the transaction and holding costs for simplicity, that’s a profit of $40,000 on the renovations, right?

Maybe. Maybe not. You see, what you have to take into account is what that property would be worth in 2006 if no improvements had been done. Let’s say the general market growth had taken the value of that unimproved property to $450,000 during the 2004-2006 period. This represents a profit of $50,000, $10,000 more than the profit achieved through the home improvements being done.

By doing the improvements, the home owners needed $60,000 to fund the renovation costs, as well as all the time required to supervise the renovations and/or do some of the work. And they would have made more money by doing absolutely nothing!

You might be thinking, “Well, it doesn’t matter really, because the property is still able to be sold at a profit”, and to an extent you are right. The problem occurs when the market stops growing, and the market flattens out.

During 2005, thousands of property renovators on the east coast of Australia were caught out in exactly this way, when the property market in major cities went decidedly flat after a strong boom period ended in 2004. Because the market had stopped going up, many renovators who tried to sell their properties found that the market price of the property was less than the original cost plus the home improvement costs.

Those renovators who did not actually have to sell, had the option to wait for future increases in the overall market to lift the price of their property enough to cover their costs. But those who had to sell after carrying out unwise home improvements found that they were facing losses, in some cases very substantial losses.

The flow-on effect for the Australian market has been that there are few property investors around now, and expenditure on home improvement products is sliding.

The property market in the US is still quite buoyant, but there are many signs that the market’s bull run is coming to an end. This is a time for home improvers to be cautious.

It is still possible to undertake profitable home improvements, but renovators need to follow strict guidelines and be very disciplined in their approach. Home improvements need to make financial sense whether the market is going up or not. After all, no-one wants to be caught once the music stops.

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