It’s easy to get into valuation trouble when we focus too much on price per sq ft. Seriously, this can be a massive problem leading to major heartache during escrows. Okay, that sounds so dramatic, but it’s important to know how to explain how price per sq ft works. Let’s talk about this by using my favorite analogy – Starbucks cups. I wrote about this six years ago, but it’s time to expand some thoughts. Here’s round two.
NOTE: These are Sacramento prices. Are they different in your area?
BIG POINT: The larger the cup, the less you pay for each ounce of coffee. Or let’s say it differently. Smaller cups of coffee tend to cost more per ounce. This is an example of economies of scale, and we see this principle all the time when buying products of different sizes. If you don’t believe me, check the labels when you go to the store. But this isn’t just about buying drinks or chips. This is also something to keep in mind in real estate.
BIG REAL ESTATE TRUTH: The larger the house, the less you tend to pay for each square foot. That’s a huge point, and let’s say it a different way. Smaller homes tend to have a higher price per sq ft compared to larger homes. This is a principle we see when looking at county stats, but it’s also something we tend to see in neighborhoods (assuming we have enough data). Just like coffee costs less per ounce the more you buy, it tends to cost less per sq ft for the more house you buy. That’s the big idea.
95757 Example: This visual shows a ZIP code with conforming tract homes. Do you see how smaller homes tend to have a higher price per sq ft? And larger homes have a lower price per sq ft? That’s the big point.
PICK YOUR POISON: This example isn’t intended to tackle all aspects of price per sq ft, but only help stir conversation. I’ve used Dad bods and Lamborghinis too. My advice? Use what works for you.
THE PRICING PROBLEM: We can miss value in residential real estate when we hijack a price per sq ft figure from a dissimilar house down the street. Imagine, for instance, using the price per sq ft from a 1,000 sq ft house to price a 4,000 sq ft property in the ZIP code above. After looking at the visual, we’d probably end up with a really inflated value, right?
A VIDEO: I forgot about this, but I made a video about abusing price per sq ft. Here’s some rationale and word pictures (added 3/30/22).
UNSOLICITED ADVICE: Pay attention to price per sq ft, but don’t forget to look at similar properties (comps) when trying to figure out value. And feel free to use the Starbucks cups analogy. I use it frequently in conversation to help paint a word picture when talking about real estate. Here’s 5 things to know about price per sq ft in case you wanted to read more.
REAL WORLD EXAMPLES: I’ve included some examples in various neighborhoods around the Sacramento region. The truth is there is always a price per sq ft range, size matters for value, and property characteristics can make a massive difference in the price per sq ft.
PROBLEM VISUALS: Okay, you might not care, but I wanted to mention that price per sq ft visuals can be problematic. When an area has a huge variety of prices or custom homes, this means price per sq ft can be ALL OVER THE PLACE (just like the comps are all over the place).
AN ASTERISK: Sometimes the higher end of the price market doesn’t always follow a perfectly predictable trendline for price per sq ft. What I mean is a 5,000 sq ft custom home won’t always sell at the lowest range possible just because it’s larger in size. I think some of the graphs below show this. But Gary hit the nail on the head in the comments as he said, “I think if a larger home doesn’t drop in price per square foot, then you’re likely seeing extras like view, site size, quality features like pools or elaborate finishes/design, etc…” Bingo.
TWO THINGS: 1) We need to be careful about imposing a trendline from tract homes on custom homes (preach it brother). In other words, the trendline for tract homes doesn’t mean anything for custom homes because these are two different products; 2) Sometimes buyers pay a higher amount per sq ft for larger custom homes simply because they recognize the quality of the home, location, view, etc… Of course, that’s something we would hopefully see in the comps too.
Here are a few examples where some of the larger homes have a huge price per sq ft. Do you see what I’m talking about? The largest homes still aren’t at the very highest price per sq ft in the market, but it does look like these homes are able to command a higher price per sq ft than the overall trendline from all other sales would maybe suggest.
FREE MARKET UPDATE NEXT WEEK: Next week I’m doing a free market update on Zoom for SAFE Credit Union. It’ll be one hour and I hope everyone leaves with lots of nuggets. This will focus on the Sacramento market, but you don’t have to be local to attend (sign up here for free).
MARKET STATS: I’ll have lots of market stats out this week on my social channels, so watch Twitter, Instagram, LinkedIn, and Facebook.
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Questions: What is the best way you’ve found to explain how price per sq ft works or doesn’t work? What sort of problems have you encountered with price per sq ft in real estate?
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Well, I just heard today that Starbucks is getting rid of their cups! Lol!
Too funny… you have to bring your own or use their real ones!
So says their Director of Environmental something or other… ?
That would be wild. Haven’t heard that yet. 🙂
Ryan, love the analogy especially since you and I first met a Starbucks…. Before I go into my little thought about Starbucks, let’s keep one thing in mind, I still don’t know what they call the different cups in Starbucks, A) I don’t go in very often and B) I get tired of folks behind me laughing at the cowboy who has no idea what a tall vs a whatever the big one is. Now here is my little thought:::::
let’s use the big cup of coffee and throw in a whole bunch of pumps, special milk, whip cream on top and the sprinkles. All of this pushes up the price of the cup and the price per ounce. If your cup of coffee doesn’t have three pumps with a half twist of something, the be careful about using that price per ounce to compare with other coffees or the price per SF when pricing your home to list. It can come back to burn your hand without the special cardboard holder. As always great post, Ryan.
That’s right, Brad. We did meet at Starbucks during my cappuccino-drinking days (those days are gone). Great point too. The more stuff you add, it just won’t compare per ounce. I think we could probably do a really cool object lesson like this to teach about PSF. The wheels of my mind are spinning now.
I always tell real estate agents that if quality, condition, location, and amenities stay the same, then price per square foot goes down as the property gets larger. I think this would hold true even with the very large homes. I think if a larger home doesn’t drop in price per square foot, then you’re likely seeing extras like view, site size, quality features like pools or elaborate finishes/design, etc…
Good points Gary. That’s half of what I planned to say.
I just need to hire you to write my posts. This is so good. I actually updated my original post and linked to this comment. Thanks Gary.
All the content of a Starbuck’s cup is essentially the same, not so with houses, even though those houses are in similar location !!
Thanks Truett. For sure. There is something to be said about diminishing returns and size though. That’s my big point here. And yeah, what a house has in terms of features can make a glaring difference in PSF.
It’s fascinating to see the difference in price per sf, in same sized houses. Which makes sense to a degree, but is there really that much of a difference in upgrades location etc, in El Dorado? Always interesting food for thought Ryan, thank you.
Thanks Karen. Amenities can make a massive difference. Lot size, upgrades, location, panoramic view, etc… can be enormous. Imagine a house that sells for $800,000 with a stellar view, pool, upgrades, etc… compared to the same 2,000 sq ft house that sold for $600,000. The difference would be $400 PSF for the $800K house and $300 PSF for the $600K house. In higher dollar areas there can be massive price ranges, so it gets really interesting with PSF. But this is where we need to consider the entire package of what the property offers. If a house has a pond, barn, view of hills, privacy, pool, etc… then it’s not just the house somebody is buying. This is where PSF as a metric gets a bit wonky in my mind. The PSF truly represents EVERYTHING on the lot.
I sell appraisals like Starbucks sells coffee. I like to set my appraisal fees on price per square foot. Smaller houses I charge 50 cents per square foot. Larger homes I only charge 30 cents per square foot. Makes it sound less expensive when a 4000 sq ft home appraisal is $1200. Looks like it works both ways.
Love it Mark. Thanks. I was going to say, I have a tiny home at 300 sq ft that I want you to give me a quote on… 🙂
Hey Ryan, great stuff as always. Can’t believe the original Starbucks post was 6 years ago.
Gary stole most of my thunder by pointing out the importance of location, quality, views, amenities, etc.
I think of fixed costs to help understand how price per square foot declines as homes get bigger. The lot price is the same whether a big home is on it or a small one. That fixed cost is divided by a smaller floor area in a smaller home versus a bigger home, bumping the price per square foot up.
Thanks Joe. Excellent commentary. I think that’s spot on. When I talk about price per sq ft I tend to have a slide where we look at two homes next door. The larger house very likely costs less to build. That’s definitely a huge factor here. It’s still amazing at times what buyers will pay for homes on a price per sq ft basis. I think sometimes buyers and sellers are quite fixated on this metric.
Great post Ryan! I use the analogy of pricing a car per pound. A lighter weight vehicle doesn’t mean it is less expensive and visa versa.
Thanks Jamie. Yes, that one works well too. I have a price per pound post too. Haha.
Thank you Ryan well said. I think besides the PSF, the lower price range (price per sq. ft) is also driven up by 1st time buyers and still amazingly investors due to lack of rentals.
Thank you Ryan, I have followed your comments for many years and I highly appreciate all of them.
Thanks so much Vicki. I really appreciate you. This is such an important conversation to have. The good thing is there isn’t just one analogy either that will perfectly represent all aspects of price per sq ft. On that note, if any onlookers have a word picture to suggest, speak on. I’m definitely interested.
As always, these are excellent points and analogies on the economies of scale as square footage goes. Not a Starbucks fan but that is besides the point. Pleasure to see you the other day in class too!
Thank you so much Andy. I appreciate it. I’m glad we got to talk for just a minute. It would’ve been nice to catch up more. See you sometime this year at another class hopefully… And I’m sorry to hear you don’t like Starbucks. 🙂 In truth, I only drink tea now, so it’s about the same to me these days no matter what shop I’m at. In other words, I’m not a fanboy of any coffee / tea shop.
Ever since I saw the original post I have been using this analogy to explain it to our own clients. Often it feels like I’m bursting their bubble because it’s not what they want to hear. It’s nice to be able to send them a blog so they are angry at you and not me! lol
Have you ever done a post about not using average $/SF for a neighborhood? Whenever someone calls me to sell their home and they want to talk about average $/SF I know it’s going to be trouble. It’s another one where I wish they would be angry at you and not me.
Haha. It’s funny to hear you say this, but I completely understand what you mean. I think it helps when we have a third-party voice to convey a concept. There is something powerful about an outside expert. On a side note, I once tried to convey something like this while on a webinar. I said I would be a third-party so to speak, and the leader of the company got really offended because the perception was that I was saying agents weren’t an authority. It was an awkward moment, and unfortunately my intent was completely misunderstood. The truth is we all need to surround ourselves with experts because it helps us win. We even see this with kids where we can tell them to do something, but they might only listen when somebody else tells them. It’s just how things work.
I don’t have a post about averages, but the problem is an average isn’t going to perfectly represent every property. What if the property is above average or below average? That can become a massive issue that only points us to ask the most important question. What are SIMILAR homes actually selling for? I think I would try to point toward the need to look at similar rather than average. I mean, an average is only a benefit if a home is below the average.
This blog post should be required reading by ALL real estate agents. Great way to revisit an old blog post with additional insight. Keep up the great work, Ryan.
Thank you so much Tom.
This is an easy way to explain economy of scale. There are so many reasons to disqualify PPSF but just like Case-Shiller, the public (and most agents) can’t digest more than 15 sec burps of info. In 15 secs I ask how can we assume: tax records are accurate, market conditions are consistent, buyer/seller motivations are consistent, condition is consistent, quality is consistent, lot characteristics are consistent, updates/quality are consistent, area desirability/reputation are consistent….they give me the tilted head like the old RCA dog (very boomer analogy) hearing something for the first time – https://tinyurl.com/mvbpd48u
Thank you Hank.
Absolutely right!!! I shared it on my broker/lender/appraiser FB page! Very informative
That’s so cool. Thank you so much.