Balance portfolio and hedge against slide..

Pal

Still not convinced I'm afraid.

What you have done is upgrade your property by (I assume) borrowing money to extend it.  You have not made a return on investment yet because you haven't sold to take advantage of the increase in value of your home.  If you want to deal in notional prices then fine, go ahead, but why not just double the value that you think your house is worth and brag about that to your neighbours instead?  A completely made up value is no different from any other completely made up notional value that you choose to put on your home, so why not go the whole hog and really pretend that you are now very wealthy?  It is only when you choose to sell to rent or live in a gutter that you can truly know whether you have made any profit or not.

Your point on moving up a house bracket is a good one, but again, until you move you have no idea whether or not you have really made a profit.  

An example:  Your flat may have been worth £100k, and lets say you had a mortgage of £70k on it. (a 70% mortgage).

You then borrow £30k and extend.  A passing estate agent says that it is now worth £154k.  You now have a 65% mortgage, so are notionally in a better position regarding negative equity.

The problem is that you have borrowed to fund the increase, and will presumably pay the money off over the next 20 years or so.  The interest payable means that you don't know how much you are going to spend on that extension until the day you pay it off.  You also don't know how much you are going to be able to sell it for.  So there is no way of knowing how much profit you will make, especially in terms of ROI.

You also don't know whether you will profit from the extension in terms of being able to upgrade to a larger house at a later date, because you don't know what will happen to house prices.

In my example if you sold now, you would be able to put a deposit down of £54K on your next house and reborrow the original £100k mortgage to buy at £154k, which you would not have been able to do before.  A good result.

However if house prices fall £20%, your equity falls to £23k, but you still have a mortgage debt of £100k.  If you had not extended you would have only £10k equity, but you would only owe £70k.  In these circumstances you have not profited from the extension and are in a worse position once the additional mortgage capital and interest are taken into account.

The extra £13k "profit" could be put towards getting you on the next housing rung, but you would still have a £30k higher mortgage. The extra interest on the £30k would outweight the £13k profit in the long term, so in this example, no financial profit has really been made.

In practice this is just playing with numbers and the real world is much more complex than this. It is also probable that your circumstances are far better than portrayed in my example.  

I am not saying that people should not extend their houses.  My point is that people should not necessarily extend their houses simply to make a paper profit, and that they should certainly not be "banking" that paper profit and going out and spending more money on the basis that they are somehow wealthier than before.  

By all means extend if you plan to realise the gain by either selling to rent immediately or by rolling it over into a bigger house.  But if you are not planning to sell, an extension is best viewed as a home improvement that is costing you money, rather than an investment which will make a paper profit you can never spend.

As an aside, assuming you borrowed the money to extend, then the percentage ROI if you sell immediately is likely to be much higher.

E.g. using my example, zero cash paid out (it was all borrowed) for a £54k notional gain is an infinite percentage return on investment.  In practice cash would be paid for selling fees, decorating materials and so on, but if you genuinely only made 180% notional ROI (ignoring borrowing interest) then you either had a lot of cash savings sitting around or your extension didn't add a great deal of value to your home!  ;D

John_M_Business

Interesting discussion. True, a paper value is just that, until someone actually puts their money down.

I also understand that, were the market to decrease significantly, then my investment profit margin would be eroded - but it's practically impossible for the profit to be completely eroded because of the level of 'gain'. Even if the 1992/3 drop was resembled, I'll still gain financially AND be higher up the ladder than before.

Living in a good residential part of West London - any extensions / basements (I did both at the same time!) / lofts done to a good standard where you aren't ripped off by a builder should give a very strong yield primarily because of the cost per square foot of properties in this area.

I'd also say that it wasn't just for commercial gain in any case - I have an expanding family, and want room for more I am not a professional developer, I built this place to be home. The gain is a blessing and a bonus.

Finally, I would also say that what I'm definitely NOT doing is spending my paper gain... it's all going on the re-mortgages >:(