What Is ROI? Return On Investment, Explained
What is ROI? By understanding what it means and how to calculate ROI, you can decide which home improvements are worth it.
Q: We’re looking to renovate some rooms in our house, but we can’t agree on where to start. A friend recommended an ROI calculator. What is ROI, and how can calculating it help with our renovation budget?
A: First: What even is ROI’s meaning? ROI is an acronym for “return on investment.” ROI is a valuable measurement for anything a person puts their money into, especially a home. ROI can help homeowners understand the value of a house and how improvements will increase or decrease that value—or leave it unchanged.
Different kinds of home improvements have higher or lower ROIs, depending on housing market trends and the house’s overall livability and longevity. By understanding ROI, including what it is and how it’s calculated, homeowners can make informed decisions about improvements, especially when it comes to hiring professionals to take on tasks.
Return on investment is a measure to evaluate an investment’s profitability.
Buying a home is an investment–it’s likely the costliest purchase someone will make in their lifetime. Improvements, remodeling, and additions are also investments because of the upfront costs and the effects on a home’s overall value.
Return on investment is a way to look at how all expenses (buying a house and improving it) will pay off if a house is sold or refinanced. Some costs make a home more marketable because they’re in-demand or convenient, and other expenses, even necessary ones, have little to no effect on resale value. Some renovations and additions can make a house less appealing to future buyers.
In terms of ROI, home improvement aims to increase the home’s value by an amount that is nearly equivalent to the project’s cost.
To calculate ROI, divide the net return on investment by the cost of the investment.
An accurate return on investment calculation begins with an accurate record of all costs associated with a project. This is the cost of investment. For example, if a homeowner is working on remodeling a kitchen, expenses include materials, labor, and interest payments on loans. Other projects may have additional costs, like uncovered supplemental projects (e.g., replacing tiles for water damage and discovering further damage that needs repair), testing and permit fees, or increased property taxes resulting from improvement.
The net return on investment is the value a project adds to a home when pricing it for resale. It’s calculated by subtracting the initial value of the investment from the final value of the investment.
Net return on investment = final value of investment – initial value of investment
Net return can be anywhere from a few thousand to tens of thousands of dollars, and it depends on a variety of factors, including region and housing market fluctuations.
A rate of return calculator, which considers the project time frame, can help a homeowner work through the ROI formula:
ROI = net return on investment / cost of investment
ROI is usually expressed with a percentage or ratio.
With the calculation above, ROI will be expressed as a decimal or ratio. However, it’s common to see ROI expressed as a percentage.
To find the percentage, apply this formula:
ROI = (net return on investment / cost of investment) × 100 percent
A high ROI indicates that the net return on investment is close to (or higher than) the total cost of the investment. A high ROI is desirable for home improvements because it means the money put into projects has tangible value. On the other hand, a low ROI is less desirable, as the net return on investment is much less than the total cost of the investment.
Sometimes, a low ROI is unavoidable, or a project is more sentimental than financial. In any case, anticipating whether ROI will be high or low using an investment calculator can help homeowners decide what aspects of the home to invest in.
Siding, minor kitchen remodels, roofs, and windows have the best ROI.
Not all investments are equal. Some are expensive but have lasting benefits. Others may be budget-friendly, but they’re too personalized to be enjoyed by future owners or are viewed as an unwanted hassle.
The investments with the best chances for high ROI affect the most noticed and used home features. For instance, replacing the siding of a house can have an ROI of up to 95 percent or more. While it doesn’t directly affect the indoor living experience, updating the facade affects onlookers’ and potential buyers’ perceptions of the home.
Likewise, updating roofs and windows have a similar effect because it puts potential buyers at ease. A maintained exterior represents a house that will last—and incur fewer hidden expenses.
Inside, kitchens and bathrooms are worthwhile investments. A minor kitchen remodel (meaning the kitchen is updated rather than completely gutted and reworked) has one of the highest ROIs of all home remodeling projects.
It’s important to understand the ROI of home improvement projects and renovations if you plan to sell.
For homeowners planning to sell, ROI is a necessary consideration for home improvement projects. Using the basic ROI calculation or an ROI calculator can determine what investments are worth your time and money.
While average net returns are helpful to understand the value of an investment, they don’t tell the whole story of selling a home. The housing market is regional and variable. A home improvement that typically has a favorable ROI may not have the same effect on a home sale in an area where housing prices don’t follow trends. There is also no guarantee that a home’s value will be higher when it’s time to sell.
The region also affects demand. If home improvements set a home apart in a way that makes it too different from other houses around it, it may be challenging to sell. When thinking about home improvements and ROI, homeowners need to anticipate the needs of future buyers in their area.
To get the most ROI on a renovation, do your homework and shop around for materials and contractors.
People can’t control the housing market, but they can manage their expenses. Labor and hardware can get pricey, but finding clever ways to lower project costs can improve ROI. This means shopping around and comparing prices. Home improvements are sizable financial commitments, so they deserve time for thoughtful research.
For a more wallet-friendly way to get supplies, some contractors will offer unused materials from a previous project for a reduced price. If delivery fees are a concern, the cost of renting a trailer for pick-up and transport might be an economical alternative.
For homeowners interested in having a direct hand in the outcome of their investments, there’s always DIY, even if it’s only for part of the project. For example, many homeowners will opt to perform the demolition portion of their remodeling on their own to cut costs. However, if you are concerned about safety or your ability to commit the necessary time and resources to a project, it’s best to hire a professional.