Buy this… and turn it into something like this…
What is the Return on Investment of the Equity in Your Home?
The answer may surprise you…it’s a big, fat ZERO. This is the first in a 4-part sears about how you can put your equity to work for you. “But my equity is already working for me” you might say. The fact is that equity sitting in your home (whether it’s your primary residence, vacation home, or investment property) is dead equity – your home will appreciate based on what the market does whether you have no equity or own your home free and clear. Equity in your home provides ZERO return on investment. On the other hand, you need a down payment to purchase your home so if you put 10% down on a $200,000 home ($20,000 down payment) and that home appreciates 5% in the first year ($10,000 in appreciation), the return on investment (your down payment) is 50% ($10,000 / $20,000) not including closing costs – just trying to keep the math simple. If your home appreciates 5% in the 2nd year you own it ($10,500), your return on investment is 35%, 15% less than the 1st year. The ROI will continue to decline, assuming the same appreciation rate, as your equity grows. As your home increases in value, the amount of appreciation you get from a given appreciation rate (in this case, 5%) grows, but it grows the same whether you re-up your loan or leave the equity in your house.
One of the great advantages of owning real estate is leverage and leverage decreases – along with the ROI – as equity increases from appreciation and principal reduction. This is why it’s a good thing to pull equity out once your equity has grown to a certain amount. A cash-out refinance on a conventional loan is best when the loan-to-value after pulling the money out is 80% or less; hence, a cash-out refinance of a $250,000 home would have a loan amount of $200,000 or below. If increasing equity decreases my return on investment and doesn’t help my return, what can I do to increase my ROI. Let’s take a look at the first option we’ll discuss.
Renovate and Update
My wife and I have owned 5 homes and we have renovated / landscaped each of them. Our plan has always been to renovate them as soon as possible – we’ve often had to do it in phases so that we can afford to do what we want, but we want to enjoy the renovations and not just renovate to sell and move on. Each of our last two houses were going to be our last house but the housing and financial market crash that began in 2007 made us have to adjust our plan for our 3rd home. The need to move closer to my aging parents required us to sell our 4th home. The home we are currently in will be our home at least until my son graduates from high school in 2019 and maybe longer but it probably won’t be our last home since we don’t like having backyard neighbors who like right down on us.
37 Years Old and in Dire Need of Renovation…
Our first home was 37 years old when we bought it (Sandy, UT) and was in serious need of renovation. It was a small home and we spent about 7 weeks rehabbing the home before moving in and about $12,000 (the cost of the home was $104,500 when we bought it in 1995). It was about 1,100 square feet and we added about 250 square feet on the back end of the extra long garage in addition to redoing all the floors, putting in new cabinets in the kitchen from a big box store, painting every room in the house and then refinishing the basement, including adding a 3/4 bath. We sold it for $129,500 1 year and 10 months after we bought it because I was transferred down to Vegas.
Transferred to Vegas – Let’s Buy a New Home That Doesn’t Need Any Renovation…
The 2nd home we bought (Henderson, NV) was brand new (3,316 sq. ft.). The walls were all a stark white and the backyard was dirt. Over the 8 years we lived there, we did a fair amount to it. The key is that we did as much as we could as soon as we could so that WE could enjoy the house while we lived there. We did a lot of painting and we replaced the tile countertops with granite. I replaced all of the cheap baseboard with some really nice baseboard, added some crown moulding in a few rooms and a buffet area in the dining room. We also put a covered patio in the back yard along with a basketball court and a hot tub. We bought the home in 1997 for $223,500 and it was worth about $500,000 when we pulled money out to buy our dream home (a semi-custom home that we built) and an investment property.
Business is Great. Let’s Build Our Dream Home
Our 3rd home was our dream home (5,300 sq. ft.) – we lived in it for about 7 years before the market crash made it impossible and impractical to keep. It was gorgeous on the inside but we had to invest about $100,000 to make the backyard a paradise. We put in a nice basketball court, an in-ground pool with a separate hot-tub, a built-in BBQ (that wasn’t hard to sell the wife on – she loves it when I do some cooking) and then a play area with an in-ground trampoline. We also put in palm trees and plants to add color and life. The cost of that house with the landscaping was about $900,000. Like in our previous houses, we enjoyed all of the upgrades we did. We refinanced our house to consolidate the 1st and 2nd mortgages and pulled out money to invest.
The Best Laid Plans of Mice and Men…are still subject to the whims of the financial and housing markets
When the Vegas market collapsed (there were far more loans back then than are available today and many of them were loans that were very risky), we had to sell our dream home. We then bought another great home that was a bank repo. It was a beautiful custom home that was about 11 years old (4,900 sq. ft.) – it had a great view of the Strip and was in good shape, for the most part, but needed a few things including lots of painting. We purchased this house for $446,250 and sold it 3.5 years later when we moved back to Utah for $606,500.
We purchased our current house for $415,000. It was a 30 year old home with a newly renovated kitchen but the flooring throughout the house was really bad as was the color of the paint. We painted the entire house (with the exception of two rooms that we didn’t know what we were going to do with), put in a wall in the basement to create an office for me (the family room in the basement was the length of the entire house and it just didn’t make sense), and new flooring everywhere (except those two rooms) – we did vinyl flooring that looks like wood in the kitchen, eating area, family room and hallways and then we did carpeting everywhere else. We then refinanced and pulled out a big chunk of money so that we could utilize the two rooms that were doing nothing. Our master bathroom and closets were extremely small so we used one and a half of those rooms to increase the size of our bathroom and closets and we used the other half of the unused bedroom and converted it into a laundry room which we moved from the main floor. We put a nice mudroom where the laundry room was – right off of the entry from the garage. Finally, we put in a nice new garage door (the one for the cars) and painted the other outside doors in the same color scheme and we added on to our back patio and put in a hot tub. In just over two years, we have increased the equity in our house by about $150,000 – $185,000. We have invested about $110,000 in the renovation but we have been enjoying every square inch of our house and lots of family and friends (we had about 20 people staying with us over Christmas of 2017) have enjoyed it as well.
Our REAL Return on Investment
In every home that we have owned, we have had great use value out of the improvements we did to the home. We enjoyed the renovations for years (with the exception of our first home when we had the surprise job transfer) as well as the increase in wealth. While the market crash that occurred from 2007 – about 2012 (at least in Vegas) did hurt us financially, we were able to buy a really nice replacement home for a great price as well and we have rebuilt nicely because we continued to work the plan of consistent investing and renovating our homes. In the upcoming articles in the series, we will explore the opportunities of buying vacation properties, investment homes, and homes for your kids to live in when they go to college. In the meantime, if you have any questions about mortgages or renovations…or renovation mortgages, please feel free to contact me at 702-812-1214, 801-893-1737 or email@example.com.