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New housing starts are down; renovation of homes, up. Both should be down.

Posted by John Reed on

Housing starts are way down. But home renovation is up.
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Is that contradictory?
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Yes.
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Why is it happening?
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Home builders or most them are competent businessmen. They know that under present conditions, the sale price of a new home is less than the cost---unprofitable.
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Are home owners incompetent? Yes. Remodeling Magazine does an annual article showing how much profit the most common renovations make in resale value increase.
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ALL Aare unprofitable. The best, like just exterior painting. may clear 90% of their cost, but still means they lose the other 10%. And that's in normal times.
So why do homeowners do them? Ignorance is bliss. They ASSUME it's profitable. They do not check. They do not want to know.
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Generally, the only profitable rehabs turn apartments with overly large rooms into ones with an additional bed room or convert hotel space into apartments. In both cases. No increase in the outer dimensions of the structure can be needed---just moving interior walls and adding plumbing and/or cooking fixtures.
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Higher mortgage rates are probably deterring renovation somewhat.
What about expanding the existing home instead of buying a bigger one? Well, then you trigger all sorts of transaction costs and maybe taxes. That is another calculation. Basically, that is choosing the lesser of two evils.
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Homeowners THINK their improvements are profitable. The reason is they fail to remove the beta. Their house is worth, say, $400,000. They do a $20,000 improvement and sell it two years later for $459,000. $59,000 exceeds $20,000, therefore profit.
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Sorry, but that's incorrect.
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To remove the beta---what would have happened absent the improvement---they need to see how much the $400 000 homes that were NOT improved went up at the same time. Probably around $45,000. So the $20,000 improvement only raised the value by $14,000. No financial genius secret decoder ring for you.

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