Is price per square foot important? This is a question that lots of buyers and sellers want to know. In real estate, as with many things in life, the easiest solutions to a problem are not always the best solutions.
Take calculating the value of a home for sale. Realtor’s, sellers and buyers all want concepts that they can use to convey the value of a home quickly and easily. One of the most familiar concepts used in real estate is the price per square foot.
Take the price of a home, divide it by the square footage of the property, and you have the price per square foot. Easy right? Yes – and people that use this means of valuation get the price wrong nearly every time!
Although the price per square foot can be useful in learning about the general value of real estate in a particular area, it is a poor indicator of a home’s actual value.
There are so many components of a home that must be considered. This, by the way, is part of what keeps professional Realtor’s working. Determining the actual value of a home is much more complicated than a simple formula using only two variables.
Some real estate agents, however, who are not that skilled in pricing a home will use this simple formula in trying to estimate home value.
This is a gigantic mistake and one that causes so many Realtor’s to price homes WRONG! Price per square foot is one of the poorest means of valuing a home! What real estate agents and consumers should understand is the most important factors in pricing a home for sale. In the article, you will see what matters and what doesn’t when trying to price a home accurately.
The danger of using price per square foot to value a home are real as explained below.
Understanding Basic Home Types
To clarify why the price per square foot is so inadequate a measurement, in most instances, it can be useful to understand the different basic categories of homes. They are:
An economy home is built to appeal to lower-income buyers and people who want to spend as little as possible on a house. Builders are careful to use materials that will keep costs down, so every part of the home will be made using materials that – while meeting code requirements – are not of the greatest quality or desirability.
Everything from the roof to the plumbing fixtures to the flooring will be low-end. The home is certainly functional, but compromises had to be made to build it to a certain low price point. This kind of home is made in the most cost efficient manner.
Most homes are of standard build quality. Everything in the home is constructed of more durable materials than the economy home. The different components of the home, such as the cabinets, may be mass-produced, but they are produced using higher quality materials that will last longer and hold up better to wear and tear.
Standard homes can contain components from both economy homes and possibly some elements of custom homes.
Keep in mind every builder constructs homes differently. Some build in a particular manner where the quality of the materials used is not visible to the laymen who is not in the construction industry.
While most buyers can tell the difference between a Marvin window vs. a builder’s grade window, most would not be able to see the difference in quality from one heating system to the next.
Home “A” might have a heating system that costs $10,000 while House “B” has one that is only $6000.00.
A custom home kicks it up a notch, adding elements that are not found in lower categories. The cabinets in this home may be custom made by hand.
The flooring may be hardwood, while the counters may be granite. In this kind of home, you may have higher end appliances, better windows and bathroom fixtures. As the name suggests, custom homes can also feature unique, customized amenities that are not typically seen in a standard or economy home.
Custom homes are unique and reflect the characteristics and desires of a particular buyer. Custom homes may also be built with other architectural features that make them more expensive to construct, such as intricate roof lines and higher end materials used on the facade. It is not uncommon to see stone or brick as siding choices.
Luxury homes are the top end of the housing market. These are the homes that feature the best of everything. Indoor swimming pools, home theaters, wine rooms and more. The home is built out of the best materials, and it is entirely possible that every feature in the home is customized to the needs of the individual that had the home built.
A luxury home is considered the best of the best. These are the homes that are constructed with the highest grade of construction materials throughout. There is no expense spared on anything and the amenities seen inside the home are sometimes enough to make your mouth drop!
Comparing Apples And Oranges
When you consider the different types of homes that are out there, it is easier to understand why the price per square foot is not the best tool to calculate the value. The cost of a single room in the luxury home may match that of an entire economy home.
Price per square foot only gives you average or median ranges to help you understand market trends. So when someone asks is price per square foot the best way to value a home the answer is clear cut and dry – NO it is not!
The best way to show you this is to give you a perfectly detailed example. Let’s say you have two homes that are 2800 square feet.
Home “A” has the following amenities:
- A single tab roof shingle and builders grade windows.
- A dropped flagstone walkway and concrete front steps.
- Carpets throughout the first floor and linoleum in the bathrooms.
- The kitchen and baths have “stock” cabinetry.
- Formica counter tops in the kitchen and bathrooms.
- Plastered door openings with no wood trim.
- Hollow core doors throughout.
Home “B” has the following amenities:
- An architectural roof and Anderson windows.
- A brick walkway.
- Hardwood floors throughout the first floor and tile in the baths.
- A custom kitchen.
- Granite counter tops in the kitchen and baths.
- Crown moldings throughout the first floor and wide base molding on the first and second floor.
- Solid doors throughout.
- Central air.
- Sprinkler system.
- Security system.
Now keep in mind these homes are the same size. You don’t need to be a rocket scientist to know that home “B” should sell for significantly more than home “A.” Let’s now go a step further and put home “B’ in the best neighborhood in town and put home “An” on a busy road.
Real Estate agents who want to use price per square foot to calculate value this way end up looking like fools. Using the price per square foot method with home “A” selling at $400,000 would give you a price per square foot of $142.86.
Sorry boys and girls but house “B” sure as shit is not going to be selling for $142.86 per square foot. This, however, is exactly how some real estate agents and consumers like to calculate a home’s value.
Some home buyers will see that such and such a home sold for X amount on Main Street and try to transfer that calculation to the home they are thinking of making an offer on. This is NOT how real estate valuation works.
Then, of course, there are some home sellers that will see house “B” selling for a certain amount per square foot and will automatically assume their home should sell for the same even though they do not have half the amenities and live in a far less desirable location.
I remember a few years ago a gentleman who was interviewing Grafton Real Estate agents. He wanted to use price per square foot to come up with his properties value. Clearly, he did not understand by using this simple method he was setting a price for his home that did not work.
As many sellers do, he decided to list with the agent that went along with his thinking. Needless to say, I was back in the door four months later cleaning up this sellers mess he created by overpricing his home.
This illustration above clearly shows that you can not take the price-per-square-foot and multiply it by the square footage of the home you are thinking about buying. There are way too many variables with a home’s characteristics to make generalizations like that.
Both buyers and sellers need to understand this is not how to properly value a home. If you are selling a home the price you set is the number one reason it will sell or not. Overpricing will cause failure nearly every time. Both buyers and sellers need to understand proper real estate valuation techniques to get an accurate picture of a home’s true value.
Getting Into The Finer Details
Another thing to consider about pricing a home is just how much each aspect of a home can impact its value in the marketplace. There are so many different things that can go into a home’s price calculations that are not readily apparent when you look at the price per square foot.
You may have a home that is two-story or a home that has gone through major renovations, or a home on a big lot. Each of these factors will influence the price.
Comparing a home on a large lot to a home on a smaller lot will skew the price per square foot – even if the home on the larger lot is nicer, its price per square foot can easily be less than the house on the small lot. A home in better area may demand far more than a home in a not-so-nice area, which can change the price per square foot as well.
The way square footage is calculated can also impact the price per square foot. One home may have a square footage calculation that includes a finished basement, while the next may not. Comparing both homes by their price per square foot then becomes useless.
For those who don’t know this, below grade square footage is worth much less than above grade space. Any appraiser will can confirm this for you. So if you have one home that is 3500 square feet above grade and another that has 3000 above grade and 500 square feet below grade – all other things being equal the home with 3500 above grade is worth far more money.
Did you also know that the actual size of a home will have an impact of what it sells at per square foot? Yes, it’s true. Generally speaking, smaller homes will sell at more per square foot than larger homes. As a home gets larger in size, the price per square foot often drops. This is another danger of using price per square foot to put a value on a home.
Another example is bedroom counts. A smaller four bedroom home may have considerably more value than a three bedroom home with gigantic rooms. In these instances, the smaller home can be worth the same or more than the larger home just for the fact it has the extra bedroom.
To take this a step further you could have a large two bedroom home that could be considered to have functional obsolescencebecause the appeal of having two bedrooms is limited. All of these homes could have the exact square footage, and the bedroom count would have a serious impact on the total value of each!
Location Makes A Huge Impact on Value
One of the variables that proponents of assessing a home by price per square foot often forget is location. They don’t say location, location, location in real estate sales for nothing. It is one of the most important factors for placing a value on a property.
A home selling on the main road will sell for something different than the same home on a country road. The same home selling for X on a country road will sell for something else than if it’s located in a neighborhood.
Taking the same home and placing it in the BEST neighborhood in town can cause it to sell for something even more.
Does price per square foot take into consideration a home’s location? No, it does not! This is why real estate agents often emphasize how to choose the right neighborhood is critical to long-term appreciation and resale value.
It is those that understand this concept who end up ahead in the long run. The difference in value between one neighborhood to the next can be substantial. Sometimes even being located in one school district over another can influence the value of two identical size homes.
Price Per Square Foot Exception
For those that like to use price per square foot as a means to evaluate property values there is only one circumstance where it can be helpful. The appropriate word to describe this situation would be UNIFORMITY.
The best example is when you have a neighborhood which only include a few homes styles and similar lot characteristics. The community has been developed by one builder who has constructed all the households in a relatively similar manner using the same materials and amenities in all of the homes.
Price per square foot can be helpful as a measuring stick for value because everything is the same. The location is the same; the lots are similar and they way the homes were built are close to one another. This is the only way that price per square foot will give you an accurate valuation point.
Other Poor Home Value Indicators
Price per square foot is not the only lousy value indicator that people use to value property. Some of the others include:
Zillow estimates – A Zillow estimate or Zillow Zestimate as they like to call it is a terrible indicator of home value.
Assessed value – an assessed value is another terrible means of arriving at a value. This is one quite a few real estate agents will incorrectly use. Take a look at the article and see why it is off so much. Essentially there is no correlation between assessed and market value.
Refinance Appraisal – a refinance appraisal the majority of the time is to either get a lower interest rate on a loan or take equity out of the property. For the lender to make additional money, they want to see this work. Enough said.
Getting Pricing Right
The only real way to understand the value of any given home is to calculate the value based on the individual home, preferably with the help of an experienced Realtor.
A real estate agent, if she or she has been at this very long, should know how to measure up the value of a home in a particular area and give you an idea of what it is worth.
How to determine real estate market value is something a true professional understands. Price per square foot calculations should make up little, if any, of the final figure the Realtor gives you. The number is just not that important when comparing home prices.
Your best bet is to find a real estate agent you trust, with a proven track record, and have him or she assist you with the buying or selling process. Your agent will be able to examine all the finer details and come up with numbers that are useful to you.
Accurate information is the foundation of good real estate deals, so make sure you have someone with you that can help you access such information. It can make a world of difference in the outcome.
If you have been trying to sell your home without any luck and remember your agent talking a lot about price per square foot in calculating your value, you may be priced too high.
Here are some of the more common ways to know your home is overpriced. This was an exceptionally well-written article by Kyle Hiscock on home pricing.
By now you should understand that trying to use price per square feet as a means to value a home is a awful decision. There are much better ways for placing a value on property including a detailed analysis from a professional Realtor who knows the differences between location, amenities and other important factors such as condition and age.
Estimating the value of real estate is far more complicated than using average dollars per square foot. This is yet another way to get your home value wrong.
You need to account for the unique characteristics of each piece of property and either credit or debit the value of the building as appropriate, based on recent sales of similar homes. The size of the home is important, but it’s just one facet.
A skilled real estate agent will account for factors like views, location, finishes, layout, amenities, and styling. These are all important in determining a home’s true market value! Hopefully, you now clearly understand why using price per square foot is a terrible method of pricing a home.
Article by: Bill Gassett, October 26th, 2015 email@example.com