Is that kitchen remodel worth it?

In order to determine whether home improvements are worth the cost/headache, people compare the cost to the projected increase in value. For investment properties, I often see people compare the cost to the expected rent increase. For instance, if a $10,000 kitchen improvement will translate into $100/mo increase in rent, then it takes ~100 months to recoup your investment.

Let’s look at why this approach is misguided.

Continuing with the example above, let’s also remember that this increase in $100/mo translates into an increase in annual net operating income of $1200 (for sake of this example, let’s say costs and other income sources remain unchanged). Depending on your local cap rate (short for capitalization rates, explained at this link), this can, and often will, have a dramatic effect on the value of your property. If your local cap rate is 8%, your $10,000 just added $15,000 in value (at least on paper). If, on the other hand, local cap rates are 5%, you just added $24,000 in value (again, at least paper). The extra $100/mo in rental income is, of course, a very nice bonus.

While this all sounds great, the reality is that it’s usually not this simple. For starters, you can’t get much done for $10,000 these days. And whatever you could get done for that amount probably won’t, by itself, increase the rent you can demand by $100. You probably also lose rental income during the time of the remodel/repairs, so that needs to be factored in.  In the end, the point is that if you have an upgrade you are confident will improve the rent by ~$100/mo, you can probably “afford” to spend $15k-20k on the project, between lost rents and direct project costs.