When properly applied Price Per Square Foot is an incredibly useful metric for evaluating residential real estate opportunities. When misused it can lead to real problems in determining an accurate valuation. Improper use of Price Per Square Foot can make a home appear to be worth more or less than it’s actual value. I wanted to dig in and discuss what Price Per Square Foot is and how to best use available data when evaluating real estate.
Most simply, Price Per Square Foot is a measurement of the average cost of a built out (finished) property. As one simple number it should allow us to compare the relative values of different properties. This seems to be straight forward but therein lies the rub! Don’t be fooled by misapplying this metric. Let’s start from the beginning.
What Is Price Per Square Foot?
Price Per Square Foot is the price of the home divided by the total indoor square footage.
A 2000 square foot home that sells for $400,000 is selling for $200 per square foot.
$400,000 divided by 2000 sq ft = $200 per square foot
This is where the fun starts!
The tricky part of using Price Per Square Foot is that it only applies for comparable properties. This means you CANNOT compare the Price Per Square Foot of two homes if they are not considered comparable homes. A comparable home is a home in the same or similar neighborhood in the same condition with the same amenities. Not evaluating comparable homes is like simply calling all cuts of meat beef and then being willing to pay the same price per pound for filet mignon as for ground chuck.
We previously discussed a house selling for $200 per square foot. The next home that we examine is selling for $150 per square foot. Will comparing these two homes provide us with any benefit?
The first house was 2000 square feet. The $150 per square foot home is 4000 square feet. It happens to be selling for $600,000. The first home has three bedrooms, two baths and a pool. The second home has five bedrooms, three baths and is located a few miles from the first home. These both may be great properties but what you can’t do is tell which is a better value from the Price Per Square Foot numbers because these homes are not comparable.
Let’s dig in to this!
If a community has three homes for sale, one for $600,000, one for $400,000 and a 3rd for $225,000 and these homes are each 4000 sq ft, 2000 sq ft, and 1000 sq ft respectively, adding up the total sales prices and diving it by the cumulative square footage does NOT give us a usable average price per square foot.
An appraiser needs homes to be of similar square footage, age, and community to be considered comparable. The fact that the average price per square foot of these three homes is $175 means nothing for comparative purposes for any of these three properties.
The house which has garnered our interest is know as the “Subject Property”. If the 2000 sq ft house selling for $400,000 is our subject property we need to know what is in the house. When was it built? How many bedrooms? How many full and half baths? Is there a pool? What is the general condition of the appliances, a/c units, roof, etc.?
This information is what will drive our comparison. We need to find a home with similar age, square footage, condition etc., if we are trying to gain an accurate perspective on the value of the subject property verses that of comparable homes in the area.
When working with either a selling or buying agent or broker it is really important to understand the source of the data used for creating average price per square foot numbers. Specifically, were the properties included in the analysis really all comparable properties or are there some that don’t belong and are just muddying the water? Now you should be able to keep the numbers honest with the information discussed here today!
As always, feel free to comment, e-mail or call me regarding this or other related topics!- Stefan