Let’s look at one of the most common value mistakes made with square footage in real estate. This error is extremely easy to make if we’re not careful, and it’s something that happens quite a bit in the real estate community. I’d love to hear your thoughts in the comments below. I hope this is helpful.
Here’s how the error works:
- A property sold for $205,000.
- The house is 1164 sq ft.
- $205,000 / 1164 = $176 price per sq ft
- Now apply $176 to any difference in square footage with other properties. For instance, if a house is 100 sq ft smaller, the value difference between the two houses is $176 x 100 = $17,610.
The Big Error: When we apply $176 for the square footage adjustment, we make a huge mistake. Why? Because $176 represents everything about the property from the structure, lot size, upgrades, driveway, layout, landscaping, sewer connection, bedrooms, garage, etc…. So when we apply a figure that encompasses the entire property to only one little part of the property (square footage), it’s very easy to get an off-base value adjustment.
A market-based methodology: If you want to know how much square footage is worth, it all comes down to comparing homes in the neighborhood. In this case we need to find other similar-sized homes to the 1164 sq ft model. What type of price difference is there? Why is there a price difference? Is it the square footage? Condition? Upgrades? Location?
In this case I found a property that sold for $197,000, but it had 100 less sq ft and one less bathroom. Assuming there are other sales out there like this too (we need more than just one example), we now see the combined value difference for the extra 100 sq ft and one bathroom is only $8,000. In other words, buyers were really only willing to pay about $8,000 for the extra square footage and bathroom. That’s a far cry from the $17,610 figure we came up with above, right? We could take more time to figure out how much the bathroom contributes to the $8,000 and how much the square footage contributes to the $8,000, but let’s not make this post too long.
The Point: Be very careful about making a square footage adjustment by using the entire price per sq ft of a property. This is applicable for any price range too – not just the lower end of the market. How much are buyers actually willing to pay for the extra square footage? The best way to know is to start finding some sales that are a bit larger and others that are a bit smaller. Assuming all else is fairly similar, what is the price difference? For more information, check out how appraisers make square footage adjustments and choosing comps like an appraiser.
Questions: Do you have anything else to add? Any stories or points to share?
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Great stuff Ryan – I love this and fantastic points and items to consider as a buyer.
Thanks so much Heather. I appreciate it, and you are always so encouraging. Yes, you are so right about buyers. I’d add that sellers ought to be in tune with this principle too. It’s very easy to price a property too high when adding too much value for extra square footage. “My extra 200 sq ft is worth at least $50,000”. Maybe. Maybe not. What story do sales in the neighborhood tell? Are properties 200 sq ft larger actually commanding a $50,000 premium?
Nice that you have a whole suite of related articles. It’s oftentimes a difficult concept for lay people (or Realtors pushing for a value) to wrap their heads around. Hitting this topic from different angles helps people understand that the real estate market is more than just a math formula.
Thanks Mike. Well said. Yeah, it’s about seeing the numbers in their proper context, which is way different than just knowing numbers. I shared this example in a recent class, and I think it was eye-opening since some in the real estate community are taught to make adjustments like the example above. This is yet another reason why communication between appraisers and agents is so valuable. We can all learn so much from each other about how value works. Mike, I hope to see a new post from you soon. Keep up the great work.
Tantalizing title Ryan. Over use of price per square foot among properties of different size, quality, condition, and location is a common error. Thanks for the reminder.
Thanks Gary. It’s been fun to talk about price per sq ft lately. It can be a very valuable metric, but it can also be used in ways to quickly lead to an off-base value. I hadn’t hit on this angle before about making an adjustment by using the total price per sq ft of a property. I hope it’s helpful for others to see an example like this.
Thanks for bringing this up Ryan and explaining it in a simple way. I think this mistake is made by a lot of people, including agents that are trying to price homes. Not to dog agents, but it is an area that we as appraisers can assist them in by explaining the proper way to look at the contributory value of additional square footage.
Thanks Tom. I appreciate your tone too. This is not about dogging any one group in the real estate community at all, and I’m hopeful we can forge a fantastic conversation with many parties here. Valuing properties takes skill, whether working as an agent or appraiser.
Buyers and sellers often knowingly & wrongly choose the method that favors their price…. so its good to know how to get to the appropriate answer and break it down. Sometimes you have to just say no. Isn’t this why we learned Algebra? (fixed + variable costs = price).
Well said, Jeff. It’s easy to ignore the numbers since real estate is such an emotional thing. “My house is the best one the neighborhood has ever seen.” Being objective about pricing is definitely not an easy thing, but it’s so important (especially if we’re in a very price sensitive market).