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valuation methodology

How to avoid one of the biggest value mistakes made with square footage

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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.

big value mistakes made with square footage - by sacramento appraisal blog

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.

what is the extra square footage worth - sacramento appraisal blog

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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5 reasons why median price increases don’t translate dollar for dollar to actual value

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If the median price goes up by 2% in one month in a zip code, does that mean you have 2% more value for your property? Should you add that 2% to a new listing or appraisal? Or since the median price rose by 75% from early 2012 in Sacramento County, does that mean you have 75% more value? Not necessarily.

NOTE: Understanding how the median price works is important for valuing properties and communicating with clients.

Image purchased and used with permission by Sacramento Appraisal Blog

What is the median price? If you lined up all sales in a county or zip code from lowest to highest price, the median price would be the sale in the middle. Over time this figure can help us see how a market is moving, but applying median price increases from a zip code to a particular home can get us into quick trouble.

5 reasons why median price increases don’t translate to actual dollar for dollar increases:

  1. what-is-the-median-price-by-Sacramento-Appraisal-BlogSales Volume: The monthly median price is based on how many sales there were in a given month. If there are few sales in a market, the median price could see a huge swing, which means it can go up and down very quickly (which means we should be very careful about applying the increase or decrease to our property’s valuation).
  2. Less junk sales at the bottom: In 2012 and 2013 cash investors gutted the distressed market (low-priced short sales and foreclosures), and then flipped many of these low sales at higher levels. This essentially means the bottom of the market was removed. Now imagine the median price again, which is the sale in the middle of all sales if you lined them up by price. All of the sudden the sale in the middle got much higher because the bottom distressed part of the market was removed in a short period of time. Thus the market on paper shows very significant median price increases, but that’s really because of the bottom disappearing, right?
  3. Seasonal Moods: The median price tends to see a huge uptick during the early Spring.. For instance, imagine the median price increased by $25,000 from January to March. Does this mean values increased by $25,000? Not necessarily. It’s just the stale sales from Fall were much lower in price, and now current values are in high gear for the Spring (which is normal for Spring). Sometimes values in the beginning of the Spring are aggressive and they seem incredibly high, but in reality they might be picking up where the market left off at the end of Summer (or maybe slightly above). This is why we need to look at sales well beyond just the past 90 days.
  4. Larger Homes: Imagine there were larger-sized homes that sold last month compared to the previous month. We might look at the median price and say, “Wow, look how much the market increased last month”, but in reality there were simply bigger homes that sold at higher levels that made the median price increase.
  5. Zip Code vs Neighborhood: Not every neighborhood is experiencing the same trends as the entire zip code, and not every price range behaves the same way either. The zip code might show a 2% monthly increase in median price, but are neighborhood listings being priced higher or lower than recent sales? Are listings spending longer or shorter times on the market? Are sellers getting what they ask for? We have to be sure to take a hyper-local look at sales and listings in the immediate neighborhood before blindly applying zip code trends. The zip code might show a 2% median price increase, but maybe after looking at the numbers in the neighborhood itself, values in the neighborhood increased very modestly by maybe 0.50 to 1.0% in actual value over the month.

I hope this was helpful. As always, thank you sincerely for reading.

Question: Anything else you’d add? I’d love to hear your take.

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