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Real Estate with Integrity and Common sense
Proper Uses of Price Per square foot valuation
All too often buyers, brokers and sellers splash about that such and such sold for so much per square foot. To clear the air, price per square foot analysis is a back end test for an appraiser to determine if the comparable sales being used with the adjustments give the subject property a reasonable market value. It should also be noted that all appraisals in the end state the actual date for which the value is given, that it is a statement of opinion from the appraiser and that the value given is based on facts known to the appraiser(Usually the appraiser does not have all of the facts).
Seldom does a real estate broker or seller employ the same methods as that of an appraiser. As a buyer you should consider learning a few simple methods to establish what you should be offering on a property that you are interested in acquiring.
If a home is the type of property being considered start with a realistic value of what a standard building lot might sell for without any home built upon it. Let's say we agree that $50,000 will buy a standard city lot. If a lot is larger or smaller give it a reasonable premium or reduction. A review of lot sales can assist you in determining what these values will actually end up being. If you consider this element alone it should become obvious why price per square foot is outright wrong. Within a subdivision you might find a 3500sqft home and a 2200sqft home. If we consider the building lots as both equal ($50,000) then using price per sqft tells us that on the smaller home of the two the lot cost is $22.73 per sqft and on the larger home the lot costs is $14.29 per sq ft.
This represents an $8.44 difference. If I were going to use the smaller homes sold price per sq ft as a comparable sale to price the larger home I would automatically be in error $29,540.00, here's the math 3500sqft x $8.44 per sq ft = $29,540. Let's continue. Most well built homes will have the same cabinet box count and a similar quality finish. It is wise to consider cabinets, fixtures, heating and air systems and so forth when seeking an accurate value. If the average well built home has $35,000 of cabinets assuming a 13'x13' kitchen, 3 bathrooms and laundry room then the small house will require $15.91 per sq ft to pay for cabinets while the larger will require $10.00 per sq ft. In the end, the cost of each building component is divided by the actual square footage to come to a cost to build or replace the property on an actual cost per foot. In the reverse, if I used the larger house as a recent sold comparable to the smaller home I would end up under pricing my home.
The larger home cost of cabinets was $10.00 per foot. My home is 2200 sq ft. As a result I give my home a line item value of $22,000 for cabinets, a loss of value of $13,000 because the actual cost was $35,000. I trust you are getting the point. Perhaps you do not want to go around dissecting every possible property for actual value and that is okay, but use a simple equation of removing the value of the building lot, divide the balance by the actual sq ft and do this for all sales being used as comparables and do it again for any property you are considering. If the numbers are relatively close then you have reasonable comparable values in what is being offered to what has sold. If the price per sq ft is greater than $4-9.00 per foot you are either about to pay too much or you are using the incorrect comparable sales in you analysis.
If an agent or seller starts out with quoting price per sq ft as a marker of value raise an eyebrow and listen closely because it is entirely possible they have no idea what they are doing and are simply repeating what they have heard others say. With so many choices out there for a reputable broker don't make the mistake of hiring someone who is less than qualified. A well schooled broker will know what credit and debits to make to come to a reasonable market value and advise a potential buyer of what to offer. Likewise, this same broker will be successful in counseling a seller on a price that a new home to the market should list for. Be careful not to play the pricing game of list it high and wait for offers because they may never come as buyers are savvy and may have a better eye for value than most sellers because they are out looking at all of the possibilities.
The appraisal theory known as the Principle of Substitution says that a ready, willing and abled buyer in the marketplace usually will be unwilling to pay more for a property than the cost of acquiring an equally desirable substitute property.
