What really is a construction budget?

Is a project budget?

  • The cost of my project?
  • My guess of what my project will cost based on what?
  • A contractor’s close guess of what the project may cost?
  • The amount of money I want to spend on my project regardless of what it is?

When I hear the term “budget,” I can’t help but think of what I can afford, not what things cost. A good example is the household budget. When developing a household budget, we usually try to balance our income with expenses such as utilities, food, car payments, rent, and mortgages. We have the luxury of looking at what those items cost in the past and then can forecast them into the future, balanced with our income. Hopefully, this influences our spending behavior, so some is left over. 

Should it be called a project budget?

The term “budget” is used in construction in multifaceted ways, leading to misinterpretations and misunderstandings. The nature of the word budget alone suggests that it’s not a set price and can increase or decrease; therefore, how dependable is the number really? Is a “budget” dependable enough to make some of the most significant decisions of a lifetime? Not so sure.

One of the biggest mistakes a homeowner makes when beginning a substantial remodel or new home project is pulling a “Budget” number out of thin air. Suppose you want to build a new home or add to your existing one, and you hear from your neighbors what they spent, so you use that as a gauge and devise an arbitrary dollar amount. Inevitably, the work you want to be completed exceeds the “Budget” number you came up with, and off we go right out of the shoot set up for missed expectations.

A contractor or Architect may ask you, “What is your project budget?”. It’s a very valid question, especially after you whipped out a long list of your wishes for your new home. It would be best if you answered the question honestly, or once again, you are headed for disaster. But how can you intelligently provide the answer? When you create a household budget, you have solid metrics on expenses and income from the beginning and at least have a chance to meet your goals. When the time comes to build your new home, you have zero information and experience related to the cost of construction to answer the question, why are you trying?   Instead, think about it from a different perspective.

Or how about an Investment Goal?

An Investment Goal begins with how much you prefer or should invest in the property regardless of your dreams. The result of your investment in the property and project will directly relate to your household budget, which is what you are comfortable paying. So, you may have big dreams to double the size of your home by adding a primary suite, man cave and she shed but is it smart? At the very least, establishing an investment goal clears the fog so informed decisions can be made.

So here is a path to setting an investment goal. Then, you can decide how far to take your project.

Step One – Determine the value of your property today. 

  • Set up accounts at Realtor.com and Zillow.
  • Search your neighborhood for past sales and current listings like your existing home.
  • Create a spreadsheet to collect your data.  See Below.
  • Establish a value by the square footage which is what most appraisers and relators do.

In these examples we have come up with an average value of $563 per square foot.  So the value of our property is 1800 sft x $562.56=$1,012,614 give or take.

Step Two – Determine your borrowing power.

  • Analyze the estimated current value vs. your existing mortgage.  This is your equity.
  • Plug in your new estimated current value by multiplying your square footage with the value per square foot.
  • Plug in your mortgage.
  • Subtract the two to get your equity.
  • Factor your equity by 70-80% which is the maximum a lender will provide you.

In this example we have established your equity by subtracting your current mortgage from the estimated current value.  The maximum amount you can borrow is 80% of your equity or $354,091.

Step Three – Determine your Investment Goal

By strictly establishing a “budget” from the investment perspective, you have removed the emotion of that new kitchen and primary suite. This will be a baseline, so you can now make informed decisions.

  • Plug in your estimated new square footage after your project is completed.
  • Multiply your new square footage by the current market price square footage price ($563).  If you want to be more conservative reduce this value down.
  • Based on your borrowing power set an investment goal dollar amount.  In this case we upped it to $400K.
  • Plug in your new mortgage if you have one.
  • Subtract your current mortgage and your new mortgage by the new value.  In our example our new equity is $437,895.
  • Check your new loan to value percentage which in this case is 66%.

So, instead of coming up with some random, uninformed number for your dream home, we have begun to build a foundation for informed decisions and a way to answer the question to your contractor or design team. In our example, we have set an Investment Goal of $400,000. This leaves us with equity at the end of the project but perhaps not all the things you want to accomplish.  

  • The value of our home today could be in the $563 per square foot range.
  • Verifying this with a real estate agent or appraiser may be a good idea.
  • Can you afford the increased mortgage payment? In our case, it almost doubles your house payment.
  • You can now adjust your investment goal to feel more comfortable with your payments.
  • You now know how much cash or investments you may need to pitch into the remodel kitty.

Transforming your thinking from a budget to an investment goal establishes a baseline when you begin thinking more seriously about your project. This exercise happens before you start your search for an Architect or Contractor. Once you engage with your design team, you can arm them with your investment goal and pursue the design of your project intelligently. Even at that, how could anyone know the ideas that you filter down to meet the goal? There are ways to accomplish this during the design process, which will come next. 

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