Appraisal House Blog

The Fallacy of the Price per Square Foot Method
August 13th, 2009 10:57 PM

“What is the price per square foot?” In my job as a residential real estate appraiser, I hear this repeated almost daily. Other variations include “my neighbor sold for $ (x) per square foot”, or “the average in my neighborhood is $(x) per square foot”. Almost always, these comments and questions come from people who are unhappy with the valuation of their home. Unfortunately, the price per square foot method is very rarely a reasonable indication of the true market value of a property.

Let’s look at the basics: The price/sf is determined by dividing the sale price by the number of square feet of living space (also known as the GLA, or Gross Living Area, which is the attached air-conditioned space of the house). So a 2,000sf house that sells for $200,000 has a price/sf of $100. So does this mean that all houses in the area should sell for this multiplier? Of course not, because there are many variables to consider beyond the total square footage. If one house is on a larger lot, it should be worth more. If one house has a pool, it should be worth more. If one is substantially newer or is of superior original construction, it should be worth more.

An appraisal, at its root, is simply the methodology used to determine the value of the sum of the parts based on what “the market” (buyers) are willing to pay for those parts. So for every feature of your property, imagine that the exact same house sits right next door. It was built the same day, using the same materials, by the same builder, on the same size lot, with the same views, is the same floor plan, has the same number of bedrooms and baths, the same floor coverings, cabinets, appliances, garage spaces, etc. The only difference is (for example) that yours has a fireplace and the other one does not. It is our job to determine how much value the market gives to that fireplace. Or perhaps the differing feature is a 3rd garage space, a covered patio, an extra bathroom, etc. The point is, your house may be very similar to other recent sales, or it may be vastly different. The more unique your home, the less valuable neighborhood price/sf statistics are.

Many people in the industry will say that the price/sf is not supposed to exactly zero in on your home’s value, but it can be used to give you a pretty good “ballpark” idea. I disagree. To prove my point, I analyzed the last 30 appraisals my company performed and calculated the low and high range of price/sf for each comparable sale used, the average price/sf, and the differential from the actual price/sf of the subject property. The results show that only 66% of the properties were within 10% of the average price/sf of the comparable sales. So as a home seller, would you be comfortable using that method, knowing that you had only a 66% chance of being within 10% of the market price of your home?

A wide variety of factors influence the value of your home besides the actual size. Do you have a better view than other recent sales? In some neighborhoods one-story homes sell for more than similarly-sized 2-story homes. If your home has only 2 bedrooms, it will not likely sell for as much as a similarly-sized 3-bedroom home. Do you have a large covered patio? A 3-car garage when most have only 2? Do you have a pool? Is your landscaping significantly better or worse than most of your neighbors? Is your house on a busy street while other recent sales are on quiet culdesac lots with little traffic? As you can see, there are a wide variety of factors that influence the value of your home.

When is it a useful indicator? If can be a reasonable indicator when you have a home that is very similar to every other house in the neighborhood. If your subdivision was built by one or two tract home builders over a short period of time, with few options or upgrades available, then it is likely that your home’s value is in line with other recent sales in the area. If most of your neighbors have 2-story homes with 1-side brick veneer, 4 bedrooms and 2 & ½ baths, carpet in the living room and bedrooms and sheet vinyl flooring in the kitchen and baths, the same size lot, and are pretty similar in size and age, then it is probable that you are pretty close to them in terms of price/sf.

However, if you are in an area where the sizes, ages, levels of original construction quality, or levels of updating and condition vary greatly, I would highly recommend getting a formal appraisal done, or at least get a detailed CMA (competitive market analysis) from a trusted and knowledgeable Realtor.

Posted in:General
Posted by Mike Lay (Austin Area) on August 13th, 2009 10:57 PMPost a Comment

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