Source: http://www.investopedia.com/articles/mortgages-real-estate/08/add-value-to-real-estate.asp#axzz1duZ9Wd3o

Remodeling certain areas of a single-family house is an excellent way for homeowners to add increased functionality and beauty to a property at  someone else’s expense. By choosing the right project to enhance your living space, a significant portion of the expense can be passed on to future  owners in the form of increased property values. Read on to find out how.

Think Before You Build

The return on investment (ROI) of any given renovation project is a function of local market characteristics, the condition of the residential real estate market when the property is sold and the quality of the work performed. Historically and on average, certain projects, such as the addition of a wood deck, kitchen  and bathroom upgrades and window replacement, have shown the greatest ROI regardless of the property’s location or the state of the residential property  market. However, unless the remodeling project is designed to fix a structural issue or design flaw, it is unlikely that a homeowner will earn back more than the cost of construction. If cost recovery is as important a consideration as increased enjoyment from enhancing the property, then  homeowners should consider the tastes of prospective purchasers when deciding  which projects to pursue.

For investors remodeling rental property, the cost of enhancing a property can be recovered not only through sale, but also through the increased rental rates commanded by updated residences. (Owning property isn’t simple, but there are plenty of perks. Homeowners, however, need to be  careful of which projects they choose to complete, since the potential value  gains can only be realized to the extent that there are buyers willing to pay for the renovations.

Consider Your Location

When considering any type of project, it is essential to make sure that any improvements made are appropriate for the particular type of dwelling and local property area. One mistake homeowners  often make is improving their homes well above the average of neighboring  houses. Buyers are attracted to particular neighborhoods because of the services  located nearby and because houses in that area are trading in that buyer’s price  range. Although a house improved well above others nearby may still receive the  same or more interest than others being marketed, it is unlikely that it will command a premium well above average because of the extra improvements.

Real estate agents will tell you that when depressed real estate markets rebound, percentage value increases are higher for the average- or below-average-priced homes in a given neighborhood and lower for houses priced at the top of their respective markets. It is during these periods  of increased economic activity and increased real estate demand that improvements will have the greatest impact on a home’s market value.

Time also will have an impact on the ability of an improvement to increase property values. Structural or design improvements, such as building additions or finishing raw space, will add value for much longer than projects like updates to kitchens and bathrooms or technological improvements, such as new air conditioning systems, because these risk becoming obsolete over time.

Geographic location will also have a great impact on which projects will have the quickest or greatest payback. For instance, the maintenance time and cost of in-ground swimming pools make it  difficult to recover the cost of installation and in some cases will reduce the overall value of a home. However, this may not be the case in the southeast and southwest U.S., where extended periods of very hot weather make swimming pools a valuable addition for some homeowners.

Government Incentives

Because of the deductibility of mortgage interest from income taxes, Uncle Sam may help to subsidize home improvement, making the cost of construction even less burdensome for property owners.

For the less risk-averse, property owners that have accumulated adequate equity in their homes can use financial instruments, such as a cash-out refinance or home-equity loan to finance their construction projects. Using these methods, the only cash necessary to complete the contemplated projects would be the interest payments to maintain the loans, which in most cases are tax deductible. The principal will be repaid when the property is finally sold.

Project Returns on Investment

The ultimate reason to take on any home remodeling project as an owner-occupant is the enjoyment received from living in an updated home. For those hoping to profit from a remodel as well,  there are several sources that will give some insight into expected payback for particular projects. For example, REALTOR® magazine publishes an annual “Cost vs. Value” report that compares the cost of common remodeling projects and shows the payback that homeowners can expect. These payback estimates are based on the residential real estate market fundamentals at the time and the average cost of construction.

Table 1 are national average estimates, but homeowners can find more specific information at Remodeling Online that will provide the same estimates for different geographic areas of the U.S. These average payback ranges for the most common remodeling projects give prospective sellers a broad indication of which projects have the greatest probability of returning a bulk of the project cost at sale. Differentials in average recoveries are explained by the scope and quality of work performed, with smaller, less-useful projects being on the lower end of the range.