Have you ever wondered how appraisers come up with square footage adjustments? Why is the adjustment sometimes so low? Is it just a guess or is there some sort of methodology? Let’s take a quick look at four options for determining how much extra square footage is really worth.
4 options for making adjustments for square footage:
- Make up a Number: Not a good method. Any adjustment in an appraisal report is supposed to be based on the market instead of a guess.
- Use one standard figure: Sometimes appraisers are known to use one cost adjustment figure for every single neighborhood. This is bad since some neighborhoods will pay far more for extra space. For instance, a lower-end neighborhood in the Sacramento area could easily see adjustments around $30 per sq ft for extra square footage, but a higher-end area might see adjustments beyond $100 per sq ft. Also, when the market is hot, the price gap between small and large homes tends to squeeze together a bit more, but when the market is declining, values tend to spread further apart.
- Use cost figures: Cost plays a role in determining adjustments to a certain extent, but keep in mind appraisers are really looking at what the market is willing to pay for something rather than what it costs. For instance, an addition might cost $50,000, but that doesn’t necessarily mean the addition would actually add $50,000 in value. How much would a buyer pay for the extra space? That’s the question the appraiser has to answer by finding similar properties in the neighborhood or market area. What if the owner overbuilt for the neighborhood? Or what if the owner added a $50,000 Yoda-shaped room? Stars Wars fans might love it, but others would probably run. The same is true for a built-in pool. It might easily cost $35,000, but buyers are simply not willing to pay for the entire cost of the pool in the resale market. Can you see why cost might not necessarily translate into value?
- Analyze sales in the neighborhood: This is the best method. Compare houses in a neighborhood to determine the adjustment. Or in other words, find matched paired sales to discover what buyers are willing to pay for a certain feature. For instance, if you find a house that sold at $230,000 at 1700 sq ft, but a very similar house sold at $220,000 at 1500 sq ft, that tells us the market paid an extra $10,000 for 200 extra square feet. In this case the adjustment for square footage would be $50 per sq ft since $10,000 divided by 200 equals $50 per sq ft. This is just one example though. It’s important to find several other matched pairs so you can make a reasonable judgement about what the market is willing to pay for extra square footage. See the example below. Can you see how the adjustment for square footage is a reflection of what the market is willing to pay?
What does the market say the extra square footage is worth?
Keys to Remember:
- Similar Size: Compare similar-sized properties to the one you are trying to value. The market might look at larger and smaller properties differently, so if you want the proper adjustment, you’ve got to stick with comparing apples to apples so to speak.
- Condition: Remember to consider upgrades and condition in your analysis. An upgraded property might sell for substantially more than a fixer. This is why properties in the most similar condition will be your best comparisons when trying to extract a reasonable adjustment for square footage.
- Know the Market: Sometimes smaller homes can sell for more than larger homes. It’s easy to assume a larger home will sell for more, but at times certain smaller models may carry a value premium for whatever reason, which causes them to sell for more. This is where knowing the neighborhood market comes in handy.
- Data Sample: Use more than just one comparison to substantiate how much extra square footage is worth. More data helps build a stronger case.
When I get asked how much appraisers adjust for square footage, I think my answer sometimes disappoints real estate agents and home owners. It would be nice to share a very concrete number, but saying, “It depends on the neighborhood and the market” is really the best answer. Most of all, real estate is about location, so it makes sense that the numbers can be different depending on the location, right?
Questions: Any insight to add or questions to ask? Or do you have any stories to share? Comments are welcome below.