My family and I love frozen yogurt. Maybe a little too much to be honest. We usually go to our favorite fro-yo shop in Brecksville called Lemonberry. It’s a simple process. You grab a cup and fill it with your favorite frozen yogurt and then pile on the toppings. When you’re done, you put your cup on the scale and pay per ounce. No matter what you put in the cup, the price per ounce is the same.
My wife, the sensible one in the family, doesn’t usually like a lot of toppings on hers. Just some fresh fruit. But our boys and I load our cups with chocolate chunks, cherries, gummy worms and whatever else we can squeeze into the cup. They may all have similar weights, but they are oh so different!
I took the pictures below from our latest trip to Lemonberry. (In order, from left to right, my wife’s, our 11-year-old son’s and mine. (I’m basically 11)
That type of pricing works great for frozen yogurt. But what about your house?
A popular way to come up with a listing price for a home is to use a price per square foot method. An individual take the sales prices of other homes they feel are comparable to theirs, and divide those sales prices by the gross living area of those homes. They use the price per sq. ft. that they come up with and apply it to the size of gross living area that their home offers.
Wouldn’t it be awesome if you could get every upgrade and lot size (toppings) you desired in your home for the same price per square foot, like frozen yogurt?
It just doesn’t work that way when it comes to home value. Different aspects of a home bring different values, with some features bringing more value than others. Using a price per square foot metric solely, doesn’t usually reflect these differences. Let me share an example of a home I recently appraised that demonstrates this.
A PRACTICAL EXAMPLE
It was a small ranch style home (about 900 sq. ft.). It had been nicely updated. It offered an average quality of construction with an average residential view. Admittedly, there were not a lot of comparable sales in the neighborhood that had sold within the past year. However, there were a few.
The listing agent told me that they had a taken one home in the neighborhood that looked to be generally comparable in terms of condition and style. The home they used sold for $118,000. It had 660 sq. ft. of GLA (gross living area). They simply divided the sales price of that sale by its gross living area. They came up with a price of $178 per square foot.
If you’re old enough to remember the show The Dukes of Hazard, remember that point when Luke and Bo were about to get into a heap of serious trouble? That’s where we’re at in this story!
They took that factor of $178 per sq. ft. and applied it to the gross living area of the subject property and voila, they had their listing price, which was $160,000.
Now before we go any further, just applying some common sense, does it seem logical that a home that is several hundred sq. ft. larger than a home that sold for $118,000 would sell for $42,000 more? Possibly. Clearly it would depend upon a number of factors. Not in this case though, as you will see.
Take a look at these adjustments I derived using data taken from that specific neighborhood and market area, using several multiple regression models and a depreciated cost new method:
Gross Living Area –$45-55 per square foot (The comparable sales I used were so comparable to the subject that no GLA adjustments were even applied.)
Site Size – Approx. $2 per sq. ft. ($87 per acre)
Basement Finished Sq. Ft. –$10-$15 per sq. ft.
Garage – $6,000-$10,000 per garage space (up to 2) (No garage adjustments were made because all of the sales had 1 car garages, like the subject)
Bathroom – $4,000-$6,000 per full bathroom (up to 2) (No bathroom adjustments were made due to the subject and comparable sales all have 1 bathroom)
Bedrooms – $3,000-5,000 per bedroom (up to 3)
$45-55 per square foot for gross living area is a lot less than what the agent used. I did make a positive condition adjustment to one of the sales of around $10,000. The other two sales were very comparable in terms of condition. By the way, I only had to make adjustments for sales concessions, one condition adjustment, two bedroom adjustments and one adjustment for finished vs. less finished basement area.
I found three comparable sales that adjusted to a range of $137,500-$141,000. My opinion of value fell between that range. Interestingly, if I had used the one sale that the agent had used to come up with their price per sq. ft., and applied the market derived adjustments above, it would have adjusted to very close to what I appraised the subject property for.
Here’s something interesting. The subject property had been remodeled by an investor the prior year, and then sold to the current owners for $140,000. The current owners had made no major additional improvements to the subject since they had purchased it for $140,000 the prior year. Now they were asking $160,000. Furthermore, sales prices are flat in this neighborhood. So, no time adjustments were supportable. This prior sale only further supported my over all analysis of the current market value of the subject.
Inquiring minds want to know: “What were the prices per sq. ft. of the comparable sales that I used in my report?” They were $153, $159 and $168. The two most comparable sales were $153 and $159 per sq. ft., with the most comparable sale in terms of site size being $153 and the most comparable sale in terms of condition being $159. The lot size of the sale with $168 price per sq. ft. was about double the size of the subject’s lot. One could argue that price per sq. ft. works if you’re using sales that are very comparable to the subject. Clearly the lot size had a specific impact on market value. Additionally, condition, finished basement area and bedroom count also played a role in the sales prices of the comparable sales that I used.
Here’s some food for thought. Can you imagine if the buyer had qualified for an appraisal waiver for this loan and actually purchased it for $20K over market value?
WHY IT DOESN’T WORK THAT WAY
What is included in that total price per square foot? Everything! That price includes the land, the bedrooms, bathrooms and basement areas including additional value for finished basement areas. The sales price also reflects the quality and condition of a home. All of these features contribute to the value of the property at different rates. An appraiser will analyze data from the subject’s neighborhood and market area, using a variety of methods, in order to determine the most probable price these components of value really add to a comparable property. Adjustments are then applied to the sales prices of the comparable sales to reflect the market reaction to these different features.
This is a far more precise and accurate way to estimate the market value of a home. Often, using solely the price per square foot of a property, muddies the waters of value precision, leading to unrealistic value expectations. Using a price per square foot method solely is like cutting out a piece of cake with your hands. You’re going to get a chunk, but it’s going to be messy.
Estimating value using specific adjustments that are reflective of the different components of value of comparable homes, is more like cutting a piece of cake with a knife. It’s more precise and less messy. (Usually)
IT’S LIKE STARTING AN OLD CAR
Pricing based solely upon a square foot metric does work sometimes. If the sales are very similar to the subject property, then it may work. Like two of the three sales I used in the report. That’s why some get hooked on using it. I get it. It’s easy. But beware! It is a huge gamble and will likely let you down at some point.
It reminds me of my first car. Here is a picture of one. This one is not mine, but it’s pretty close. This one is even the same color. (Photo credit to Bing and Velocity Automotive Journal) My friends called it the Blue Goose. It got a whole 8 miles to the gallon.
It was 17 years old when I purchased it. (I was 16 years old.) I paid $200 for it. Every morning when I went to turn it on, I thought to myself, I know it can start. The question is, will it? A lot of things had to go right for this bad boy to turn over. (It needed some work) The same is true with solely using a price per square foot metric for coming up with an asking price on a home. It can work, but will it? A lot of things have to go right for it to work. And, like an older car, it’s probably going to let you down at a time when you need reliability the most, like when you’re trying to price your home to sell.
This article is in no way intended to chastise people who use a price per square foot method to estimate value. After all, many seasoned real estate professionals use this as a way of getting into the ball park when it comes to value.
To price a home accurately, you have to consider more than just the square footage of the GLA. If you do decide to price your home yourself, I put together a list of things to think about when looking for comparable sales. I hope you find the list helpful.
By the way, what do I mean by getting “licked”? Obviously I was having a little fun with the whole fro-yo theme. According to the dictionary (dictionary.com), that term is also an idiom for “completion through discipline”. Sometimes we learn things the hard way. (I know I do!) That is a form of discipline. But you don’t have to learn the hard way when it comes to pricing your home!
If you have questions about pricing your home, pick up the phone and call an appraiser in your area. We can help you to estimate the market value of your home with more precision than solely using a price per sq. ft. metric. Even if you don’t want to hire an appraiser to perform a full appraisal, many appraisers offer services in which they will measure your home to make sure that you have an accurate idea of the gross living area of your home.
In April, I am going to be speaking to a group of real estate agents about this very topic. I always look forward to meeting new real estate professionals and discussing real estate topics in a fun and friendly environment. If you are located in Northeast Ohio and would like for me to visit your office, I would love to! Give me a call.
The week I was planning on posting this article, my friend Shannon Slater of DW Slater Blog, in Texas, wrote an excellent article on the same subject in her blog. So I figured I would postpone posting this article until now. I also have numerous friends across the country, who are appraisers, and who have also written on this topic. I actually like their articles more than mine. I recommend you read them as well.
HERE’S A LITTLE VIDEO THAT I MADE ON THE TOPIC
Here is a link to their articles that speak about the dangers of only using a price per square foot method to price a home. They all have a different flavor on this topic that you’re going to enjoy!
The Problems with the Price Per Square Foot Method – DW Slater Appraisal Blog
Why price per square foot can be an agent’s worst enemy when pricing a home – Birmingham Appraisal Blog
Starbucks cups and price per sq ft – Sacramento Appraisal Blog
I was recently on Dustin Harris’s podcast, The Approach Coach, discussing my article, ‘What Makes an Appraisal Supportable’. A big thank you to Dustin for the opportunity! I had a great time. Here it is if you would like to listen.
Here are some other articles and videos I enjoyed recently! I hope you will also…
Bowling for Housing Tax Revenue At Your Pied-a-Terre – Housing Notes by Jonathan Miller
The place where insurance & real estate collide – Sacramento Appraisal Blog
Tips for choosing comps on a unique home – Sacramento Appraisal Blog
6 Steps Agents Can Take When There Are No Comps To Price A Listing – Birmingham Appraisal Blog
9 Things You Must Avoid Doing If You Want To Price A Listing Accurately – Birmingham Appraisal Blog
Restricted Appraisal Reports Consumer Alert – Jonathan Miller on Appraisal Blogs
Should You Always Accept The Highest Offer On Your Home When Selling? – Birmingham Appraisal Blog
The 8 most interesting houses in Cleveland, second edition – FreshWater
What’s a Murderous Castle in the Middle of Suburbia Worth? – GA Appraisals, Inc.
What A Trip To Europe Might Teach Appraisers – The Approach Coach Podcast
Yes! You Can Talk To The Appraiser – Riverfront Appraisals
Are You Violating USPAP Every Day? – George Dell’s Analogue Blog