Speculating on Home Improvements

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 fi xed their land. The recoup value (the di fference 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-fi nancial constraints motive in which rising home prices loosen fi nancial 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