Dangers of Price Per Square Foot Valuations

Sep 7, 2018

When an airline executive throws around terms like “revenue per passenger mile” it sounds impressive to us lay people, who picture every air mile having the same dollar sign attached to it. But when a real estate consultant bandies the term “cost per square foot” to discuss a home’s value, it should give you reason to pause and ask a LOT of questions.

 

Like everything else, values lie along a wide spectrum, with no one price per square foot being applied to every property in a neighborhood. While taking the price of a home, dividing it by the square footage of the property, and coming up with the price per square foot sounds easy, it’s also a dangerous way to judge real value — sometimes vastly different from the value a bank appraiser would come up with. In newer neighborhoods, where two or three builders compete for business using the same types of homes, lot sizes and amenities (concrete tile roofs, stucco exteriors, granite countertops, and built-in security systems), price per square foot may be the most meaningful. But in seasoned neighborhoods, where homes have changed owners, features, and attractiveness many times over, and where infrastructure and commercial building has grown up around it for decades, using price per square foot to judge value can be a veritable crap shoot.

 

Just as an appraiser takes detailed note of a structure’s characteristics, condition, location, lot size, quality of upgrades, bed/bath count, size, etc, all have the potential to affect the price per sq. ft. and can can vary wildly. “A small remodeled home selling at $250 per sq. ft., a model match fixer selling at $175 per sq. ft., a short sale model selling at $185 per sq ft, and a home with an adverse location selling at $215 per sq ft. Thus even for one model there could be a price per sq. ft. range from $175 to $250.” says appraiser Bryan Lundquist in a Sacramento Bee article on the topic.

 

Because smaller homes cost more to build, they tend to have a higher price per sq. ft. than larger homes — that is, unless that larger home was completely updated using costly design elements or was built as a custom home with every bell and whistle installed.

 

When your real estate agent talks price per sq. ft. in a particular neighborhood, instead of taking it as an important determining factor, it’s wise to have him or her explain detail what went into that value. Of course, he or she can’t be privy to the kind of information an appraiser can pull out of a hat. “Appraisers, pay close attention to the price per sq. ft. range in a neighborhood. Some appraisers treat price per sq. ft. as a meaningless metric, but it’s actually valuable. If your value does not fall within the range (especially the competitive price per sq ft range), it’s important to be able to explain that,” says Lundquist.

 

Here are some of the most important factors in determining a home’s value:

 

There is a basic house, built for economy, to appeal to those who wish to spend as little as possible to get out of an apartment or their parents’ basement. In these homes, builders are careful to use materials that keep costs down — not necessarily of the greatest quality or desirability, but good enough for the basics so you can swap it all out as your income goes up. This applies to roofing materials, plumbing fixtures, HVAC systems, cabinetry, and flooring. Flat, hollow-core doors are often used throughout. Basic lighting fixtures are adequate but not fancy or even fashionable. Even front yards contain the requisite lawn, single tree, and a few shrubs, but you won’t find meandering walkways, aggregate driveways and coach-like garage doors.

 

Move up in price, and you’ll find homes built with more durable (and attractive) materials. Gone are the Formica countertops, the flat panel doors, the one-tile backsplash in bathrooms and the lower end plumbing fixtures. Cabinets, flooring, and even HVAC systems are more sophisticated, even though the builder may have built these homes with economy in mind as well. What lies behind the walls is important as well — those things you don’t see or notice — the thickness of the insulation, the way the outer walls are wrapped, the types of windows used — even the quality of what the house sits upon —a post tension slab or a raised foundation.

 

Now add custom-built spec, luxury or owner-builder homes to the equation and you’ll find things kicked up several notches, including a slew of elements not found in lower categories. Cabinets and built-ins are custom made. Flooring is the latest in wide-plank hardwood, perhaps laid on the diagonal for eye-appeal, countertops may be marble, quartzite (not quartz) or even elaborately-poured and buffed concrete. Crown molding may be everywhere, and architectural features, such as massive skylights and lofty beamed ceilings make it look like a resort hotel.

 

When you consider these differences, you can see how different types of homes, even in the same neighborhood, can vary widely using the cost-per-square-foot equation as a tool to determine value. The cost of a single room in the luxury home may match that of an entire economy home.

 

Lot size, floor plan, the number of renovations, and especially location, are, of course, huge determining factors as well. One home may have a square footage calculation that includes a finished basement, while the next may not, in which case comparing both homes by their price per square foot becomes useless (below grade square footage is worth much less than above grade space).

 

It’s unfair to pin errors in valuation only on rookie agents who don’t take all this into account, however. Online value estimators (where you fill in the address of a property, and it pops up with an approximate value) can be just as faulty. And appraisals done for refinancing purposes are done differently as well.

 

Experts agree that 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 a competent real estate professional — those people who do comparable calculations in their sleep and advise sellers on how to price their home. After all, their livelihood depends on their expertise. A seasoned veteran who knows the area and has seen the neighborhood morph into what it is today can estimate the value of a home in a particular area and give you an idea of what it is worth.

 

While a given home may indeed end up being worth what a willing buyer would pay for it, accurate information is the foundation of good real estate deals. Veteran real estate professionals understand that trying to use price per square foot as a means to value a home is not the best bet, since taking into account the unique characteristics of each piece of property and using recent sales of similar homes — such as views, location, finishes, layout, amenities, and styling are all important in determining a home’s true market value.

 

 

Source: TBWS

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