When is price per square foot NOT a good indicator of market value?

price per square foot not always good value indicatorA few days ago I had a real estate agent friend ask me how much homes were appraising for per square foot in a local neighborhood. It was a very good question, especially for anyone who wants to get an idea of their home’s value. And because I get asked this question a lot I thought I would take this time to explain how appraisers look at this familiar method of comparison.

The price per square foot is the most familiar method of comparison that many people are aware of. It is such a common method of measuring a properties value that it is listed right below the sales price on the sales comparison adjustment grid on the appraisal report. What you must realize is that everything about the property is summed up in the price per square foot. It’s size, condition, features and overall appeal is reduced to this one number. Because of this it is very important that if you want to find out what homes in your neighborhood are selling or appraising for per square foot in order to estimate your own home’s value you must only use houses that are very similar to your own.

If you have a home built on a slab, and you are using the price per square foot of a home with a basement, then that is going to reduce the accuracy of your estimate because the price per square of the other home includes the value of the basement. When you multiply what it sold for per square foot by your home’s square footage it will be over estimated. This is also true when you look at a home that is a lot bigger than your own. If everything else is similar, such as features and quality, but the comparable is bigger than yours, that can also be misleading because a larger home will usually sell for less on a square foot basis when everything else is the same. As the size goes up the price per square foot goes down. It is the law of diminishing returns at work, which states that the more square footage you add the less value you get per square foot for the larger size. If you multiply the price per square foot of the larger home by your own square footage then your home will be under estimated.

The bottom line is that you should make sure that the sales comps you are looking at are very similar to your own home. If your home is a one and a half story home with finished basement then try and find similar sales with like features. I wrote an article “What is bracketing and why should Realtors do it” that explains the process appraisers go through that goes hand in hand with what I am writing about here. So to finally answer the question asked about at the beginning I would say that the price per square foot can be a very good indicator of market value if the comparable sales are very similar to your own, and you are comparing apples to apples. If the property you are getting the price per square foot from has a pool, when yours doesn’t, or is on 5 acres when yours is on a half acre lot, then you are comparing apples to oranges and the price per square foot IS NOT a good indicator of market value. Does this make sense? If you have any questions I would be happy to answer them for you, just leave a message at the bottom, I look forward to hearing from you.

If you have any real estate appraisal related questions you can call me at 205.243.9304, email me, or connect with me on Facebook., Twitter, or Youtube.

Comments

  1. Great Points made, Tom. I like the “why REALTORS should do it” part. I’m working on purchase appraisal right now where home is 2900+sf and average home in subdivision is 2000sf, subject is 46% larger. Purchase price is in high $180s and average sold price in subdivision is $125K or $54/sf. The highest sales price in this market in past 12 months was $165K. When I asked Agent for their comps to support the deal, they sent 5 solds, most in mid 2012, that sold for $127,000 $66/sf 1930sf, $135,000 $65/sf 2,017sf, $148,300 $71/sf 2,070sf and $160,000 $80/sf 2,000sf. The Agent doesn’t understand bracketing and that these sales of homes 900sf smaller than subject aren’t good comps. To the Agent, subject is selling in $61/sf range and they’ve well supported their listing price based on these comps. There’s a major disconnect here between Agents and what Lenders expect is actually comparable. If I use these comps above, I will well exceed the 15% to 20% tolerances for gross and net adjustments as well as the 10% line adjustment limitation. There needs to be some remedial Agent education on comp selection in the lender’s eyes. Bill

    • Thanks for your input Bill. I have found with the agents that I speak to, that they are eager to find out what criteria they should go by to choose comps. I too find that homes are being priced with old or non-similar sales. If they used comps that were smaller and then used the price per square foot for theirs that will certainly over value the home. Many people including agents believe that a home is worth what someone wants to pay for it, which is o.k. if it is a cash sale but not o.k. if they need a loan. Banks want the opinion of market value to reflect what the majority of buyers would pay for a home, not what one very motivated person might pay.

      • You’re so right about competitive square footage. In my area I find generally the larger the house, the lower the price per square foot. That’s why it’s so dangerous to use an abstract price per square foot that really might have nothing to do with the subject property. The same would hold true for using city, county or state-wide data. It may or may not apply to the value of a specific property.

        • Good points Ryan. Cookie cutter neighborhoods are one thing because of the similarity in homes, but when you get into diverse neighborhoods that is a whole different story.

  2. Well said, Tom. Comparable Sales > Price per sq ft.

  3. I use to work in the Panama City area myself years ago. There is a more of a diversity in floor plans in the Birmingham area as you mentioned. Thanks for your thoughts John.

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