• From: Remodeling magazine November 2009
• Posted on: October 19, 2009

Lower Limit

Falling home prices pushed the value of remodeling investments down for the fourth consecutive year, but small-scale projects and replacements may be leading the way to recovery.

Over the years, the Remodeling Cost vs. Value Report has been a reliable gauge of the general temperature of the residential remodeling and real estate markets. Typically, it is retrospective, but at times it has served to forecast a trend, as it did in 2006. That year the cost-to-value ratio dropped more than 10 points, a downturn that most remodeling professionals didn’t begin to feel until a year or more later. That 2006 Report was even out ahead of existing home prices, which in most markets didn’t start to drop until 2007.

Last year, the deepening housing crisis and fourth-quarter financial market meltdown made it difficult to interpret the Cost vs. Value data, which was collected over the spring and midsummer. The results seemed to indicate that remodeling activity was about to reach bottom and start turning up, but after the declaration of a U.S. recession, all bets were off. For many remodelers during that time, it was as if a switch had been flipped; existing business was cancelled or indefinitely postponed, and the prospect of new business simply vanished.

Against this backdrop, it was futile to speculate about the story this year’s data would tell. And considering all of the economic volatility of the last 12 months, the 2009–10 Cost vs. Value Report is remarkably stable. But are things getting better or worse?

Mixed Signals

The data indicate that the trend is still headed downward: last year’s overall cost-value ratio was 67.3%, down 2.7 points from the year before; this year’s ratio is 63.8%, a considerably larger 3.5-point drop (see the graph, Seven-Year Trend). Resale values are also down, a not surprising fact given the sorry state of the housing and credit markets. What is surprising, however, is that costs for virtually every project surveyed have gone up, albeit at a slower rate than last year. This comes at a time when there is abundant anecdotal evidence that remodeling is on sale just about everywhere.

The true state of remodeling costs is difficult to pin down, but there is some evidence that material and labor costs have not changed much, and that the deep discounts we have all heard about are the result of several other factors. The most obvious is the ferociously competitive environment that has led remodelers to drastic cuts in workforce, general overhead, and profit (see Project Costs Hold Steady). Less obvious is the work that is being priced below cost, either by remodeling industry newcomers who have yet to learn what margins are required to remain viable, or by veteran contractors trying to keep busy until the economy turns around. Still less obvious are the changes being made to the projects themselves, as homeowners opt for fewer frills and less-expensive finishes.

The cost data used in the Cost vs. Value Report are based on estimates for hypothetical projects, with no reliable way to accommodate these kinds of fluctuations. At some point, the downward pressure on prices reaches a limit; how close we might be to that limit depends on what happens to the economy. If the recovery is long and slow, competition will continue to keep prices low. If the recovery comes sooner and remodeling contractors begin to hire again, prices may creep upward. How much and how fast remains to be seen. But given the general slimming down that has occurred over the past year, and the fact that new hires are often paid less than the workers they replace, it could be that prices hold steady. In that case, this year’s Cost vs. Value could be lagging behind real-world events; but it may also be an indicator, if not of where prices currently are, then of where they are ultimately headed.

Back to Basics

Since the peak year of 2005, exterior replacement projects have migrated to the top of the rankings; again this year they occupy seven of the top 10 spots in terms of cost recouped. One reason, of course, is that curb appeal has a strong effect on prospective buyers (see Curb Appeal Is King). Another has to do with cost. Replacements are among the least expensive projects surveyed — all seven in the top 10 are less than $15,000 in size, and the new entry door replacement project that earned the top ranking also happens to be the least-expensive improvement on the list. By contrast, nine of the 12 upscale projects finished out in the top half of the rankings; the most notable exception is fiber-cement siding replacement, which once again tops the list of upscale projects and ranks second overall.

If there is surprise in this year’s results, it’s the Attic Bedroom. After hovering around the middle of the rankings in recent years, it jumped into the third spot in cost recouped. Cost may again be a factor: despite a price tag of nearly $50,000, this project is the least expensive way to add conditioned living space.

Context Counts

More than ever, this year’s results need to be seen in context of what is easily the most volatile housing market in memory. Foreclosures have had a destabilizing effect on appraisals (see Not Betting on Bling), and tight credit and underwater mortgages have stalled remodeling plans for many homeowners (see That Gurgling Sound). If and when the economy begins to improve steadily, homeowners will once again begin to scratch their remodeling itch. But the four-year Cost vs. Value trend toward smaller, low-maintenance projects and an emphasis on essentials over extras will likely continue to influence their buying decisions. And if the experts are right about the permanent changes this recession could make to consumer spending habits, remodelers may need to accommodate with permanent changes of their own.

—Sal Alfano, editorial director, REMODELING.