What Is ROI? Return on Investment, Explained

Published January 31, 2017

What is ROI? Return on Investment explained (Rawpixel Ltd)

If you're thinking of making some home improvements, you will want to understand a concept called ROI. What is ROI? It stands for return on investment -- how much money you stand to get back on any particular renovation whenever you decide to sell your home.

We're not saying you shouldn't renovate for other reasons, of course -- like the sheer enjoyment you'd get out of new soapstone countertops or the addition of a half bath near your home office. But it turns out that certain upgrades aren't just highly valued by you, but by many other people who might pay a premium for them if you decide to put your house on the market. In other words, a lot of that money you poured into renovations could come right back atcha! Read on to learn exactly how much.

How to calculate ROI

A return on investment is calculated using two numbers: the cost of the investment (in this case, a renovation or addition) and the investment's gain (how much it will increase your home's selling price).

Let's say you replace linoleum flooring with beautiful oak. The contractor charges you $2,500 -- that's the cost of the investment. But when you list your home, your real estate agent says you can increase the selling price by $3,000. Thanks, rad oak floors! That's your investment gain.

Subtract your costs from your gains to get $500, then divide that number by the original cost. Ta-da! You've got a 16.7% return on investment. Or, another way to look at it is to merely divide the gain by the cost. In the above example, that would be $3,000/$2,500 = 1.2, or 120%. That's the cost you'll recoup from the upgrade; in this case, you've actually made money, which is why that percentage is over 100%.

Sadly, though, the above example is more fantasy than reality: As much as we'd like to think that the money we pour into renovations will come back at us in full when we sell our home, that's rarely the case. According to Remodeling Magazine's Cost vs. Value Report, homeowners will recoup an average of only 64% of what they paid for a renovation.

That said, ROI runs the gamut from great (think the renovation equivalent of Apple stock) to abysmal (Bear Stearns during the subprime meltdown), depending on which reno you do. So, it pays to know which home improvements have the highest ROI, if you hope to make some of that money back down the road.

Renovations with good (and bad) ROI

Determining with any degree of certainty which projects will result in good ROI may feel like gazing into a crystal ball, but there are a few tried-and-true guidelines.

Energy-efficient modifications pay off. New fiberglass attic insulation is actually the one renovation that will reap you more cash than you cough up, at 116.9% (not to mention savings on your energy bill!).
Buyers love safety improvements. Installing a steel entry door recoups 91.1% of its cost, and new garage doors will return about 90%.
Less is more. In general, lower-cost projects result in better returns. According to Remodeling's Cost vs. Value Report, four of the five projects that cost less than $5,000 rank among the top five for money back when you sell. For instance, the renovation with top returns, attic insulation, costs a mere $1,268.
Big isn't better. The five renovations that offer the worst return on investment all cost over $40,000. The addition of a master suite, for instance, will run you $245,474 but only add about $140,448 to your home's sale price, recouping only 57.2% of your costs.
Small kitchen changes can have a big impact, like replacing the hardware (new knobs often cost $2.50 or less). Or go big: 82% of homeowners prefer wood floors in their cooking area. A minor kitchen remodel will return about 83% of its cost (and think of all the great meals you'll make).
Skip the major bathroom remodel, which only earns back 65.7% of the cost, to focus on smaller projects. For a few hundred bucks, a modern sink will make the entire place look sleek. And ever-popular subway tiles only cost about 21 cents each.
Curb appeal can add 28% to your home's value. A tree sapling costs $10 and can add up to $10,000 to the value of your home. But skip the swimming pool, which recoups only 39% of its cost.

Want more info? Check out this Top 10 list of the renovations that offer the best and worst return on investment. Or, since ROI can vary greatly by region, ask our friendly local real estate agent, who can also help you understand the potential gains in your area.

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Watch: 3 Home Improvements That Pay Off Big Time (and 1 That Won't)

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