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book excerpt

Kitchen renovation in a house

From Stop Over-Thinking Your Money! by Preet Banerjee. Copyright © Preet Banerjee, 2013. Reprinted with permission of Penguin Canada Books Inc.

We are the generation of the renovation. Granite countertop upgrades, hardwood floor installations, take a wall down here, feng shui there, etc. There are so many shows on TV centred around renovation that you might start to feel abnormal if you aren't refurbishing your home. Then again, with so many people living at or beyond their means, why would you want to be normal?

There are two main reasons why you would undertake home renovations. The first is because you want to improve your living space. The second is the belief that you are making an investment that will increase the value of your home more than the cost of making the changes. My beef is with the people who use the second reason to justify their financial irresponsibility.

Don't get me wrong, I don't have anything against upgrading your living space–even if you don't get a positive return on investment. You just have to be able to afford it. (And it would be nice if it didn't end your relationship with your significant other too!)

Let's say your $50,000 renovation increases the value of your home by $75,000. That's a total return of 50 per cent on your investment. That's great if you're a flipper, but what if you live in that home for another 10 years? Your annualized rate of return is only 4.14 per cent if there is no change in the overall value of your property in those 10 years (which can happen), and that assumes the upgrade is as desirable 10 years from now as it is today. It doesn't factor in the increase in price of the property, but keep in mind that properties can have negative growth over 10 years too. You are also forgoing the use of that $50,000. If you borrow it, your cash flow is tied up paying it off. If you paid for it in cash, you have to weigh the opportunity cost of other investments.

So, as I said, I don't care if you renovate. Your new environment may bring you great pleasure and pride. And that's wonderful. There are also many renovations that make great investments. If you can afford it, go nuts. If it puts a strain on your finances though, don't fall into the trap of justifying because it's an investment.

Listen, I'll be the first person to tell you that I'm not normal, but I really dislike most renovations. Not because they don't make a house prettier or more functional: it's fun to see the before and after pictures of a reno. I get a kick out of seeing body transformations from people who start a new diet or exercise plan too. The problem I have is that one of these things is a true investment, and while the other is often justified as one, it is really nothing more than conspicuous consumption.

Eating better and getting proper exercise is an investment in your health. It doesn't have to cost much either. A friend of mine recently showed me his rock– hard six-pack abs, which Jersey Shore's "The Situation" would envy. His entire workout routine requires a chin-up bar ($50) and two chairs. He started out more like the rest of us, with a midsection another friend described as "The Predicament." This is the kind of investment I like to see: low investment, great return.

Renovations are a different kettle of fish. I'm well aware of projects that can increase the value of a house, and flippers can make a comfortable living by finding hidden gems and quickly turning them around for a substantial profit. But let's be serious. Many home renovations are falsely justified as a long–term investment. The justification helps some people rationalize their urge to spend and consume. And upgrade.

If you have the money in hand, and your finances are in order, I'll be the first person to tell you that if you want to build a staircase made of ivory (synthetic, natch), then be my guest. I couldn't care less what floats your boat when you can afford it. The problem is that many people can't afford it. They finance it instead. And here is where it gets tricky. Borrowing money to invest is speculative. If you do the same thing in the stock market, you're immediately assumed to be in the medium-high-to-totally-bonkers category with respect to your appetite for risk. The amount of paperwork you have to sign to acknowledge the risk is cumbersome because financial institutions want to cover their butts if things go sour.

Borrowing to invest in a home reno is different. You can enjoy tangible benefits right away. Your house is easier on the eyes and more functional. It makes you feel good. Perhaps you've one-upped your friends. Now you're the ones with a "situation" and they're the ones with a "predicament." But the investment works out, psychologically at least, because we're in what may be the longest secular bull market in real estate history in Canada, and enjoying 30 years of falling interest rates. If the housing market doesn't change, we could easily tease out the value of renovations by seeing how much more you sell your house for than you paid for it. If the increase is more than the cost of the reno, it's a profitable investment. But the housing market is dynamic: it doesn't go up forever, no matter what the current trends are, and you might find that one day the overall decline in the value of the house is more than the increase attributed to a reno.

This is the point at which people chime in to say that the reno was for themselves, not an investment. And this is where I say, yes, that was the real reason all along, and if you financed it over many years, then you couldn't afford it. It was just conspicuous consumption.

Guess what? We've covered everything you need to know to be financially better off than most people. As I said at the beginning of this book, the rules are not hard to understand, but they are hard to implement.

Once you've mastered them, then you can go on and pursue that A+ in personal finance. You can do that by reading more books (and I'll provide the titles of a few more to consider in Part 2). You can manage things on your own, or you can find an advisor. (In fact, I believe the vast majority of people need an advisor, so I'll provide some tips on how to find a good one.)

And you can also always check with me for general guidance. Follow me on Twitter @preetbanerjee) and I'm more than happy to answer any questions you might have.

Editor's note: This article first ran in January 2014.

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