Home Cost Per Square Foot: Not a Good Estimate of Value

Icon for Money for why price per square foot is not a good estimate of value

What is a Home Worth? The Fallacy of Per Square Foot Pricing

To suggest that the home cost per square foot of one home is the same as the average home price per square foot is to misunderstand market dynamics. These values may be somewhat close together in a new neighborhood of very similar homes but may be dramatically far apart in an area of older homes, or homes that are different ages, sizes and styles.

An Extreme Example of Why Per Square Foot Pricing isn’t Accurate

Let’s talk about two homes. Same age, same size, same size lot, same street, same neighborhood. Same number of bedrooms, same number of garage bays.

If these houses were put on the market on the same day, would they fetch the same price, or more specifically, the same price per square foot?

I would say, probably not. Why not you ask? Well, we haven’t considered where these houses are located, and the condition of each.

The Typical Home vs. the Over Improved Home

Let’s go a a step further.

One house has high-end cabinets, exotic granite counters, stainless steel appliances, travertine tile in the wet areas set on the diagonal. This same house also has hardwood floors, and brand new, excellent quality carpet in the bedrooms. The paint is meticulously chosen and applied, and the furnishings are stylish and do not crowd the rooms.

The other home is builder-grade everything, and beige. The counters are laminate, the flooring in the wet areas is vinyl. Main living areas and the bedrooms are low-end carpet. Appliances are old and the beige paint has been hastily applied over other colors, so you can see some shading on the walls where the single coat of paint didn’t quite cover. The house is a crowded mess, with the owners’ possessions strewn all over the place. Oh, and do you smell dog? Or, is that a ferret?

Do you still think these houses will fetch similar prices if they go on the market the same day?

Of course not.

Which one will sell, then?

The Over Improved Home May Not Recover Money Spent on Upgrades


In an area where homes do not typically have the upgrades of the highly upgraded home described above, the sellers probably won’t recover the cost of the upgrades.

In an area where homes are typically upgraded about midway between the two homes, the over-improved one might still go under contract, but the appraisal value may not come in at the contracted price.
This is because although the buyers may value these upgrades enough to want to pay more for them, the appraiser must consider comparable homes in the area that have recently sold, and if this home is the only one with this level of upgraded finishes, the selling price of the comps may not support the selling price of the highly upgraded home.

In this situation, where the appraisal comes in lower than the contract price a few things can still keep the deal together:

  • The seller may agree to accept a lower price.
  • The buyer may agree to make up the difference between the amount the bank will loan and the price of the house (i.e., increase their down payment).
  • The buyer and seller can compromise, with the seller coming down a little and the buyer putting a little more up front.

The deal may also fall apart.

In the case of the latter, when the house is re-listed, the seller and the agent should now be aware that they may need a special buyer – one that is able to cover the spread between the amount a bank will loan (typically 80% of the appraised value) and the listed price of the home. They might seriously consider listing it closer to the first appraisal value to avoid the same problem with subsequent contracts.

A Different Spin on This Tale of Two Homes

Now, let’s take a different approach to this analysis.

What if the highly upgraded home is the typical home for the area and the slightly-shabby one lags far behind in expected quality?

Remember, these homes are the same age, same size, same size lot, same street, same neighborhood. Same number of bedrooms, same number of garage bays.

We would expect the nicer home to sell for more, and if priced right, to sell more quickly. We would also expect the market to discount the shabbier home to reflect some multiple of what it might cost to bring the home to a level of fit and finish that is typical for the neighborhood.

Remember, in some areas, most of the homes are fairly shabby and the typical buyer may see that as normal, buy it and move right in. In other areas, the typical buyer may be more inclined to spend the time and money to clean the place up before they move in.

Competitive Market Analysis (CMA) and Per Square Foot Pricing

Let’s wrap this up and talk about CMAs, the pricing documents many real estate agents use to determine the price that a home would likely fetch on the open market. For a CMA to be reasonably accurate in pin pointing a target price range a home might sell for, the agent really needs to know the area where the subject home is located. Just browsing MLS data for homes of similar size, age and location isn’t sufficient. Condition matters, as does typical condition for the area.

Averaging the costs of homes that sold, and then comparing the price of each on a per square foot basis is fraught with peril. You could be off by tens of thousands, much to the dismay of your clients.

When in doubt, get a professional appraisal.

Comments

  1. Jack Day says

    I work for a custom home builder. We are looking at going in to a development to build new custom homes. Our concern is the appraisal and our comp rates won’t be anywhere close to where they need to be because the closest city with homes similar are at least 15-20 miles away. With the exception of smaller communities which does not anything in comparision. How does this work?

    Jack Day

  2. Jack Day says

    I work for a custom home builder. We are looking at going in to a development to build new custom homes. Our concern is the appraisal and our comp rates won’t be anywhere close to where they need to be because the closest city with homes similar are at least 15-20 miles away. With the exception of smaller communities which does not anything in comparision. How does this work?

    Jack Day

  3. says

    You should have an appraiser local to the area do a feasability study. It is important that the appraiser you hire be very familiar with the local market where the homes will be built.

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Independent Real Estate Appraiser in Austin, Texas: Travis, Williamson, Hays, Bastrop and Caldwell Counties