With the possible exception of new tract home projects, using a price per square foot to ascertain value is completely unreliable. There are multiple obvious reasons why and a number of variables that will be unique to each situation. In short, do not place any reliance on this method.
Many homeowners and others interested in real estate often use “price per square foot” (PPSF) as a gauge when trying to ascertain either their homes’ estimated value or of one they might be considering. In most cases, this isn’t a reliable indicator of market value for residential properties. While used to some extent in condominiums or with new construction, trying to reasonably apply PPSF to existing construction is often pointless and can be very misleading.
Note what I said – EXISTING. PPSF is used by custom builders, in commercial ventures and often in condos. This article addresses the obvious faults of the method when used in existing detached residential dwellings.
When any analysis is being completed, the first objective is to significantly reduce the number of variables; the fewer the better and the more reliable the results will be. Consider the number of variables involved when estimating value on a square foot basis. Among the primary ones:
- Labor rates in the area. Everyone talks about “illegal workers” but many are building homes working for much less than “conventional” trades. Many complain about lost jobs but few will pay the increased costs associated with trade labor.
- Materials costs at the time of construction. Prices fluctuate like never before in swings never seen; how is the difference adjusted for? Costs also vary by location; brick is cheap in GA and more expensive in NY.
- Design and architecture. Are homes of similar detail being compared? Costs associated with labor intensive designs will naturally be more due to time, material and waste. Four sides brick is totally different than one side in terms of labor, trades needed, materials, time on the job and other things.
- Living area. Sounds pretty basic but there is no such thing as a definite figure for square footage. How it’s measured (outside or in), whether you round or are precise and what you actually count is never the same between people measuring it. Do you count the knee wall height dormers, the finished basement, the two story foyer, the garage…no tow people will have the same. CLICK HERE TO SEE HOW TO MEASURE A HOME
- Price for the lot, a HUGE variable. No two are alike and many times builders just arbitrarily price them. Things to consider here include site prep, terrain, views, external influences, size…..If there’s a septic tank, well, retaining walls…those add to the cost.
- Condition. When that home sold what kind of shape was it in? Was it enhanced just before sale to attract a higher price? What is the effective age of the home and depreciation level (that’s an opinion by the way and no two will be the same)? That obviously impacts sale price which in turn impacts PPSF.
- Owner added upgrades. What did they add that other homes lacked? Did that home have defective products like “blue pipe”, LP/GP siding or synthetic stucco? Did the owner remedy any issues? Another strong influence on sale price and PPSF.
- Incentives. Did that builder toss in a bonus to the buyer? Did they finish the basement or upgrade something you don’t know about? On that resale, did the owners give a decorating allowance? Was there an agent bonus from the builder or seller? Seller paid closing costs are common as are adjustments for “inspection items”, both hidden influences on sale price. Did any personal property transfer?
- Buyer-Seller motivations. Was that buyer in for just a weekend and had to find a place? Was that seller unexpectedly transferred, divorced, in financial trouble or something else?
- Distressed sales. Also known as short sales, foreclosures, corporate sales, REO sales….these are and will remain a major influence on sales data for years to come. Note that many builders and developers are also losing homes, not just existing owners.
- Distressed developments and lots. A ride around suburban Atlanta will reveal an abundance of white PVC sewer taps, hip high weeds, pavement leading to nowhere and other planned communities that are dead in the water. As banks look to unload lots and entire communities for pennies on the dollar, what kinds of impact will that have on PPSF? What about those communities partially completed at one price and having the developer sell out from under them?
- Area Reputation. Some areas became major hot spots for a while and are now ice cold, some were just the opposite. A few areas have actually held and even appreciated slightly despite the bloodbath. This again ties to sale price which drives PPSF.
The best method of valuation remains analysis of comparable sales, pendings and listings from the same competing market area. This remains the method of choice for the appraisal industry and the one on which to place most reliability.
Those are a few of the variables that come to mind, there are many others. Value is determined by the market; your home is worth what a well informed buyer is willing to pay at any given point in time. The best indicator of value remains a “sales comparison” approach and that is to compare your home to one that’s a reasonable alternative purchase. That means a home that would effectively fill the same role for a buyer as your home if your home weren’t available.
The appraisal industry has moved away from using the Cost Approach as a method of estimating value. The reason is due in large part to the above variables; there are simply too many unknowns in the mix. The wild economic conditions play havoc with materials costs, labor costs are chaotic and the influence of distressed inventory continues to impact the market at all levels. Estimating value based on cost or price per square foot is unreliable in most cases, don’t get pulled into that vortex.