Speculating on Home Improvements

June 01, 2013

We develop a speculation-based theory of home improvements. Housing services are produced from a mix of land and structures. Homeowners optimistic about future prices for these services speculate by making improvements, which we model as them increasing their structures holding fxed their land. The recoup value (the difference between the resale value of improvements and construction costs) is simultaneously increasing in home price appreciation and falls with construction cost growth. This prediction stands in contrast to a consumption-cum-fnancial constraints motive in which rising home prices loosen fnancial constraints and lead to lower recoup values. We provide evidence consistent with a speculative motive using data on the costs and recoup values of remodeling projects across U.S. cities.