Introduction

The home renovation and remodeling market has cooled off as higher interest rates have naturally hampered the financing that enables it. But the market has still stayed remarkably strong, with spending above 2022 levels with strong consistent projections despite high borrowing costs. What’s driving this renovation spending by homeowners and how much of it can be considered investment activity versus consumption? Most importantly, how can financial advisors help homeowners think through renovation decisions with reasonable processes that minimize common biases in how people think and feel about money. For many investors, home equity represents their largest asset, and any changes to primary or secondary homes represent major investment decisions that can involve hundreds of thousands of dollars or even more.

In this blog we’ll discuss both the rational economic reasons and psychological biases behind home renovation decisions in the current economy, and how advisor awareness and inquiry can help guide investors to make the best choices to meet their personal financial and life goals.

Why are home renovations such a complicated financial decision?

Like many real estate decisions, home renovations represent a complex combination of consumption and investment. People typically renovate their homes to make them more utilitarian and comfortable, for a variety of reasons including family, health, recreation, safety, transportation, and even their furry friends.

Yet any renovation also has implications for the underlying value of a home should the owners ever choose to move, and that value is determined by its value to buyers, not to the sellers who made the renovation decisions. Just because a homeowner loves building an addition with virtually no windows doesn’t mean that potential buyers will find that attractive. This is why advisors can play an important role in helping clients separate value from market value. Renovations that create personal value but not market value may still be right move for a client, particularly when there are no plans to ever relocate, because the joy, comfort, safety, or health that they would receive is important. But advisors can help greatly clients avoid rationalizing such renovations as investments when the renovation cost will not be recovered during resale.

Why are home renovations so common now?

High interest rates originating from the Federal Reserve’s monetary tightening policies have indeed raised the cost of renovations for most homeowners. For those owners relying on home equity or other personal loans to fund projects, the cost of that financing can be much higher than a few years ago during the pandemic era that saw mortgage rates below three percent. Even for wealthier homeowners that can pay with cash, the cost of doing so is higher because of the significant foregone investment returns available to them in even the safest portfolios of treasury-backed securities.

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