Price Per Square Foot is a Poor Value Indicator
Is the 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. Realtors, 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 who 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 Realtors to price homes WRONG! Price per square foot is one of the poorest means of valuing a home! Real estate agents and consumers should understand the most important factors in pricing a home for sale. The dangers of using price per square foot to value a home are explained below.
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 a 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 if the price per square foot is 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 countertops 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 countertops in the kitchen and baths.
Crown moldings throughout the first floor and wide base molding on the first and second floors.
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 “A” 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” 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 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.
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 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 a 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 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 on what it sells 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 an extra bedroom.
Other Poor Home Value Indicators
Price per square foot is not the only less-than-perfect indicator that people use to value property. Some of the others include:
Zillow estimates–A Zillow estimate or Zillow Zestimate 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. 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.
Conclusion
By now you should understand that trying to use price per square foot as a means to value a home is not a good decision. There are much better ways to place a value on a 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 averaged dollars per square foot. 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 market value! Hopefully, you now clearly understand why using price per square foot is a terrible method of pricing a home.
