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using price per sq ft in real estate

Starbucks cups & price per sq ft in real estate

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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.

Price per sq ft scatter graph in 95757 zip code

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.

North Highlands scatter graph to show price per sq ft among recent sales

Price per sq ft - Oak Park

Price per sq ft - Rosemont

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.

Price per sq ft in Folsom (scatter graph)

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).

An image to invite people to a free market update I'm doing. See link below.

MARKET STATS: I’ll have lots of market stats out this week on my social channels, so watch Twitter, Instagram, LinkedIn, and Facebook.

Thanks for being here.

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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Being neutral, price per square foot, and the Governor’s new digs

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I have a few things on my mind. Let’s talk about me being asked to recruit for a brokerage (really), price per sq ft, and the Governor’s new digs.

1) WHY I SAID “NO”:

A brokerage recently asked me if I would help them recruit agents. The idea was I could use my influence to attract agents to a certain brand and then get a commission for each person I recruited.

I said NO, and my answer will always be NO. I probably don’t even need to mention this, but I want to communicate clearly. As an appraiser I won’t take sides. I’m neutral in my work, but my independence also extends in the way I interact with the real estate community. This is why you’ll see me speaking in many different places and real estate offices. I’m here to educate, not advocate. The truth is if I said yes I would’ve instantly destroyed my credibility.

2) PRICE PER SQ FT:

Here’s a look at price per sq ft trends in a few local areas. I plan to share more graphs like this throughout the year if people like them. Does anyone want to see a video tutorial for how to make these? Let me know. What do you see?

Two Takeaways:

1) RANGE: There’s always a price per sq ft range, which means there’s never just one price per sq ft figure that applies to every property in a neighborhood. Sellers often want to hijack a price per sq ft figure from a sale down the street, but that’s one of the quickest ways to overprice. My advice? Pay attention to price per sq ft, but most of all ask yourself what the comps are selling for. That’s exactly what appraisers are going to do.

2) OUTLIERS: There are clear outliers. As an FYI, usually the highest price per sq ft figures end up representing the smallest-sized homes or over-the-top unique properties.

3) THE GOVERNOR’S NEW DIGS: 

Gavin Newsom is the new governor of California and he just bought a $3.7M house in Fair Oaks. This price point isn’t much in many areas of the country, but it’s actually the fifth highest residential sale ever in Sacramento County. This home is said to have over 12,000 sq ft and it’s located on 8 acres. It’s near the American River, but not on the river. Now two of the top five sales in the county have a connection to a governor (the other was the mansion Ronald Reagan started to build in Carmichael in the 1970s).

Here’s a picture I took of the front gate this week, and here’s a video from a previous listing if you wish to see the home. Not too shabby, right?

Value thought: In the future we’ll have to consider whether there will be a price premium or not for this home because a governor owned the property.

CLASS I’M TEACHING: I’m teaching my favorite class at SAR called How to Think Like an Appraiser on January 31st from 9-12pm. We’ll dig deep into comps and adjustments (and have some fun). I’d love to have you come out.

I hope this was helpful or interesting.

Questions: Would you pay more if a governor previously owned the home? What do you think of my recruiting story? I’d love to hear your take.

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Starbucks cups and price per sq ft

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I was in line at Starbucks and then it hit me. The perfect analogy for price per sq ft in real estate. While ordering my Grande drip with no room, I began to wonder how much I was paying for each ounce. Maybe that means I’m a geek, but was I really getting the most bang for my buck to buy a Grande (medium)? Or should I go with a Venti (large)? Take a look at the image below to see how price per ounce works at Starbucks, and then let’s consider a real example of this principle in real estate.

Starbucks cups and real estate - by sacramento appraisal blog

Big Point: The larger the cup, the less you pay for each ounce of coffee. Or we could say it a different way. Smaller cups of coffee tend to cost more per ounce. This is interesting, but it’s not really surprising because it’s merely an example of economies of scale, right? We see this principle all the time when buying bigger or smaller items, yet it’s easy to ignore when it comes to housing. So let’s take a look at all residential home sales from last month in Sacramento County. Do you see a similarity with the coffee?

image purchased from 123rf by sacramento appraisal blog - price per sq ft example

Big Point: The larger the house, the less you tend to pay for each square foot. Or we could 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-wide data, but it’s also something we tend to see by neighborhood (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.

Be a Great Explainer: I love this analogy. Maybe it’s partly because I’m a coffee fanboy, but in truth talking through price per sq ft is hands-down one of the most relevant conversations to master in real estate. I hope the next time the topic comes up with a client, maybe you’ll think about using Starbucks cups to explain how price per sq ft tends to work in a neighborhood. For a refresher post you can read 5 things to remember about using price per sq ft in real estate.

Question: What drink do you order at Starbucks?

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5 things to remember when using price per sq ft in real estate

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Using price per sq ft can be very dangerous. I know that sounds odd because price per sq ft is about as common as anything in real estate. Home owners ask, “How much is the price per sq ft in the neighborhood?”, and real estate agents might say, “I priced this property based on the price per sq ft in the area.” But having a correct understanding about the way price per sq ft works can revolutionize the way we see the market and value properties. Let’s unpack five principles below, and I’d love to hear your take in the comments.

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Image purchased by Sacramento Appraisal Blog from 123rf dot com and used with permission

5 principles to remember when using price per sq ft in real estate:

1) There is a price per sq ft spectrum in a neighborhood: There is never just one price per sq ft figure that applies to every property in a neighborhood. For instance, a neighborhood might easily see a price per sq ft range from $100 to $250 when looking at all sales.

2) Similar houses tend to have a similar price per sq ft: When homes are similar in size, location, bed/bath count, etc…, they tend to have a similar price per sq ft. That’s obvious, but the contrasting factor is that non-similar homes might have a VERY different price per sq ft that shouldn’t be used to value your home.

3) Property characteristics can quickly change the price per sq ft: When there are differences in condition, location, lot size, quality of upgrades, bed/bath count, size, etc… the price per sq ft can change dramatically. We might see 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.

4) Smaller homes tend to have a higher price per sq ft: It costs more to build smaller homes, so smaller homes tend to have a higher price per sq ft than larger homes. This is why it’s dangerous to use a price per sq ft figure from a smaller sale to value a larger home. A smaller home might sell at $250 per sq ft, but a larger home might be closer $150 per sq ft. Here is a quick video below (or here):

5) Price per sq ft provides a valuable context: When you can talk through price per sq ft figures in a neighborhood, and explain the above points, you are an incredible resource. 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.

CONCLUSION: Be careful about using price per sq ft to price a property because sometimes it’s like putting the cart before the horse. I recommend starting a valuation with an “apples to apples” approach where you first and foremost try to find other similar sales and listings in the neighborhood, and then subtract and add value based on any differences with your property. After you have a grasp of similar sales, research price per sq ft figures for the entire neighborhood as well as competitive properties. Ask yourself if your value makes sense in light of price per sq ft figures.

Questions: Any thoughts or insight? I’d love to hear your take.

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