How To Use Price Per Square Foot When Valuing A Home
They say that a little knowledge is a dangerous thing, and this is very true when it comes to determining values in the housing market.
One effective way to track home values in the real estate market is to track the median price per square foot over time, but this useful information, in the hands of the ignorant, often leads to a loss of money for people trying to sell a home.
Today's post is the answer to a frequently asked question: "How do you use price per square foot when valuing a home?"
Price Per Square Foot Defined
The term "price per square foot" is something builders, Realtors, and appraisers use as a foundation in home valuation. Unfortunately, it is often misunderstood and leads home sellers to mistakes in their initial asking price.
If you price a home too high, you eliminate a segment of the pool of homebuyers who might be interested in your home. If you price a home too low, you might leave money on the table. The key is to choose the right asking price, and we can determine that price with an analysis that includes (but is not limited to) the measurement of price per square foot.
Price Per Square Foot Measurements
There are two common ways to calculate the price per square foot of a home. The first method involves dividing a home's sales price by the total square footage of the home, while the second (and better) method involves dividing a home's sales price by the total heated and cooled square footage of the home. Real estate agents and appraisers often prefer the second method as it focuses on the livable space in a home.
Most of the home valuation apps on the internet (like the best one here or like the Zillow Zestimate) estimate a home's value by measuring the price per square foot of nearby homes, establishing an average, and then multiplying it by the subject home's square footage. Basically, the tools determine an area value and then apply that value to all homes in the area.
Unfortunately, this simplistic method is almost always wrong. Here's an example of why:
If your neighborhood has an average home price of $500,000 and an average home size of 2,000 square feet, then your neighborhood has an average value of $250 per square foot. Say your home is 2,200 square feet of heated and cooled space, then many real estate agents and online valuation tools will tell you that your home is worth (2200 x 250)= $550,000. But there is a huge flaw in the logic behind this formula!
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How Price Per Square Foot Fails
If all else is equal, the price per square foot method is an accurate way to value homes. Unfortunately, it is very rare when all things are equal between two homes. Here's where they are major differences that affect the valuations of homes. When considering the two homes used as an example above, I would want to know several other factors:
- Frontage: Are they both on similar lots? In many Tallahassee neighborhoods, there are beautiful lakes. The homes on the lake sell at a higher price per square foot than homes not on the lake. The same can be found in golf course neighborhoods and neighborhoods that back up to busy streets. The value of the dirt is different throughout a neighborhood. And here's a final thought on the land underneath a home. If you use the average price per square foot approach to home valuation, two homes out in the country could be grossly misvalued. Imagine a 2,000-square-foot home on an acre versus a 2,000-square-foot home on 100 acres. Many models would give them a similar valuation.
- Maintenance: Are they maintained similarly? Or has one home been recently updated, and the other is sporting 1970s shag green carpet? As anybody who watches HGTV, the home's condition matters a lot. Does one have a newer HVAC system? A newer roof?
- Grand Amenities: Homes with swimming pools are a great example in Tallahassee. But so too are homes with tennis courts, movie theaters, extra garages, etc. How does adding a pool change the square footage of a home? It doesn't! Does that mean a pool adds no value to the home?
- Source Of The Square Footage Measurement: Different areas have different norms, but square footage calculations in Tallahassee typically come from a recent appraisal or the Property Tax Appraiser's online portal. If there is no appraisal, and the home has not been sold in recent years, the square footage might have changed. Imagine using the square footage from the tax rolls on a home with an owner who has doubled its size. The online tools will not likely know about the size change and will grossly undervalue a home. This is often seen in neighborhoods where people buy to renovate, and many valuation tools fail to recognize that the average home size in the neighborhood has grown!
These are essential factors in a valuation, and it's why online tools miss the mark.
A home's value is impacted more by the features that it contains than by its raw size. Buyers are often concerned with the number of bedrooms, so a 4-bedroom home at 1,950 square feet is often valued higher by buyers than a 3-bedroom home at 2,000 square feet in the same area. Generally speaking, larger homes are worth more than smaller homes, but the features each home contains and the home's condition are important too.
You don't buy a car by the pound (mileage and condition matter most when comparing same-year models). Boats aren't sold by the square foot, nor are the shares of publicly traded companies sold by the amount of space the company uses. In real estate, price per square foot is a great way to estimate how values are collectively changing, but there are too many variables for price per square foot to be effective in determining the value of a specific home.
Accurate Home Valuation
If you want to know what your home is worth, you need an experienced, active real estate listing agent to walk through your home and prepare an accurate valuation. Beware of real estate agents who give you a valuation purely on a price-per-square-foot formula.
You want them to consider the entirety of your home's value, not a rule-of-thumb estimation. Don't rely on websites that pin a value on your home's size, and make sure your property tax assessment of size is either accurate or not used at all.
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