Price Per Square Foot Is Not the Holy Grail of Property Value

While scanning the news headlines this week I ran across an article titled “What Is the Average Price per Square Foot for a Home — and Why Does It Matter?” Because I am an appraiser this caught my eye for various reasons.

The article pointed out that you can use the average price per square foot of the sales in the neighborhood to gauge whether you are getting a good deal when buying a house. I have a problem with this because it places too much emphasis on a stat that does not tell the whole story of a property’s value.

The first and foremost goal of my blog is to inform and educate the public about appraisals as well as why and how appraisers do what they do. This includes clarifying confusing information that consumers may have about the appraisal profession or about their homes value.

More things to consider

Narrowing down the value of a property based only price per square foot, such as what was eluded to in the article, does not tell the whole story. When you only look at the price per square foot metric you don’t take into consideration variations in the type of properties that are in a neighborhood.

The price per square foot relies heavily on having accurate information about the gross living area of the comparables, which is not always known. Lastly, when you look ONLY at price per square foot you place more emphasis on the moving target of value as opposed to the more reliable physical attributes of the property.

Value can be a moving target because most people have in their mind a preconceived notion of what their home is worth and this can lead them into choosing sales that support the value they want.

I’m interested in educating the public about the fallacies of only looking at price per square foot because it can lead to inaccuracies when estimating the value of your home, especially when you use it to arrive at an asking price for your home.

Price per square foot can provide a reasonable estimate of value in certain situations. If there is a high degree of similarity among houses in the neighborhood with regard to size, quality, design, and appeal then looking at price per square foot can give you a reliable range of value.

When properties are similar, the need to make adjustments is reduced. If all of the houses are on similar size lots, have the same number of bedrooms and bathrooms, are close in age, and are similar in living area then looking at the price per square foot may give you a range of value that you can then use to reconcile a value for your property.

When there are more variations in the elements of comparison this will impact the price per square foot. For example, a larger home will sell for less per square foot when everything else is similar and a smaller home will sell for more.

A home that has a finished basement will sell for more than a similar home without a basement. This is important because if you only look at price per square foot you may use a value indicator that does not accurately reflect your home’s true value.

The one thing you must know

Even if you have comparable sales that are similar in most regards you must make sure that you know exactly how big they are in terms of gross living area (GLA). The GLA is what appraisers use when arriving at a price per square foot in their appraisal reports. You must have accurate square footage in order to calculate the price per square that you use to come up with your home’s value.

If the GLA of your comparable sale is wrong and your price per square foot is wrong by as little as $10 this can cause the value estimate for your home to be off by $10,000 for a 1,000 square foot home.

When you only look at price per square foot you don’t necessarily take into consideration all of the other physical attributes of the home. These physical features of your home should be what you use to “bracket” the sales during comp selection because the features of a property are what drives value.

Rather than looking at the average price per square foot of ALL the sales in a neighborhood you should do a comp search by picking those sales that are similar in the size, age, condition and features of your home because the price per square foot that they sell for will reflect the similar features that your home has.

Below you will see a typical sales comparison grid from a recent appraisal I did. My comp search consisted of bracketing the physical features of the property. As a result, the price per square foot was fairly close and consistent. There were small variations, mainly because of differences in age, condition.

A search of the neighborhood without regard to any physical differences resulted in a range in price per square foot from $48 to $108. The spread of $60 from the lowest to the highest leaves a lot of room for error. This range is because of the variations in physical characteristics like I mentioned previously such as size, bedroom/bath count, age, etc.

Looking at all sales is using a shotgun approach but bracketing the physical characteristics of the property and narrowing your search down is more like using a rifle because the results are more closely targeted and accurate. This will provide a more accurate value indication and will help sell the home more quickly because the home is priced to the market.

This article was originally published by Tom Horn. For additional articles by Tom Horn visit his website.

Possible Vs. Probable

1st Published on the AppraisersBlogs on October 13, 2016

Refusing to ‘rubber-stamp’ a purchase price with an appraised value to match.Recently, there was a news story out of Atlanta, highlighting an appraiser who had refused to ‘rubber-stamp’ a purchase price with an appraised value to match. What followed was an increasingly disturbing trend to find another appraiser who would. According to the story (which was full of holes and unknowns), the second appraiser ignored comps in the subject’s neighborhood and found sales in a superior location to help support the purchase price.

This situation was talked about on social media and a man who identified himself as a real estate agent commented,“The value is what the buyer is willing to pay. The appraiser gets the contract and it is their job to find data to support whatever THE BUYER agreed to pay.”

Hmmm. Why hire an appraiser in the first place then? If this agent is correct (which he is obviously not), a buyer should be able to show the purchase contract to the bank and a loan should be issued on the spot.

Though the agent’s shortsighted comment was blatant (frankly, I question the authenticity as it just seems so completely nuts to me), this kind of thinking is not isolated to a few individuals. It is often played out as I speak with agents and homeowners, and it is not confined to purchases. Many people mistakenly believe that value for a property is based on what an individual is willing to pay for it. Market value, rather, is defined in part as, “…the most probable price which a property should bring in a competitive and open market” (Fannie Mae Selling Guide). In other words, an appraiser is looking at value from the standpoint of what the average buyer would most likely pay given current market conditions – not what a single or even a select few are willing to pay.

What is possible, is not always what is probable. A good way to look at this is not from the perspective of how high a price a property might sell for, but how low. If you were a potential buyer, would you be willing to purchase the current house you live in for $1? Of course you would. Does that mean it is only worth a $1? Of course not as you would be unwilling – as the owner – to sell for that price. Likewise, you would likely be willing to sell your current residence for $10,000,000, but good luck finding a willing buyer at that price. Value is not based off of what a single person is willing to pay, but rather what is MOST LIKELY given the law of substitution (a buyer’s agency to pick another, competitive property).

This principle also plays out, not just with total property values, but with smaller components as well. I work in a fairly rural area. It is not uncommon to have a homeowner ask me, “I am thinking of building a shop on my property? Will that bring my value up?” Well, in most cases the answer to that question is, “yes.” However, it is very unlikely that the value gained by the shop will exceed the cost to build it. That fact does not always dissuade them from forking out the cash to build their shop however (because the utility to them is high), but the typical buyer will not pay a dollar-for-dollar value increase because the ‘average buyer’ will fall somewhere in the continuum between the person who loves shops more than the house itself and one who despises shops and wishes they were all burned to the ground.
Appraising is all about market conditions. Market conditions are all about probabilities and not necessarily possibilities. So no, it is not the appraiser’s job to find the comps to support whatever a single buyer is willing to pay.

Does paying off Mello-Roos early increase value?

What happens when an owner pays off Mello-Roos early? Does that mean the property can sell for more? Let’s talk about that. If you’re not in California, just know Mello-Roos are taxes imposed on newly constructed communities to help pay for infrastructure like streets, schools, and parks. So over a period of usually 20 years, the owner might have an extra $1,000 or so in taxes to pay each year.

Scenario: Imagine an owner has $20,000 in Mello-Roos taxes over the next 20 years and decides to pay them off right now instead of waiting. Is the house now worth $20,000 more?

Things to consider about value & paying off Mello-Roos:

1) Expecting the full $20,000: When sellers do something to their property, they often expect buyers to pick up the tab of whatever the price was. This is true for kitchen remodels, landscaping, bathrooms, and even Mello Roos. In this case the seller would expect a buyer to pay $20,000, but that’s probably not realistic.

2) Logic & 20 years of payments: Buyers often stay in homes for less than 10 years, so it’s unrealistic to think most buyers are going to pay for the future savings of 20 years worth of tax payments in one instant. That’s disappointing to sellers, but doesn’t it make sense? It’s just not logical for someone to fully reimburse the seller for a bill they might not actually be paying for the next 20 years. Side note: This reminds us of solar a bit because buyers probably aren’t going to pay the full cost of the system in one instant either.

3) Comps & adjustments: A property with no Mello-Roos payments is going to have a marketing edge at the least because it’s essentially less expensive to buy the house compared to others. At best there could be some value there too, though it’s going to be hard for an appraiser to support a Mello-Roos adjustment because it’s not easy to find comps where sellers have paid them off. In an ideal world we’d have three model match sales without Mello-Roos so we can analyze whether these homes really sold for more or not. If we don’t have sales, but it seems clear the market is willing to pay more based on the number of offers, price level of offers, feedback from agents, logic, data from other neighborhoods, etc…, we can always look at the range of value in the neighborhood for similar homes and choose to reconcile the subject at a higher tier of value. Thus it’s important to realize appraisers might not always give a specific adjustment, but they can still recognize an asset by reconciling the final value to a higher level (if there is support to do that). It would be nice if there was one quick formula we could apply to spit out a perfect adjustment here, but formulas wouldn’t work in every neighborhood, price range, or market. Like all things in real estate, we have to know how to think through issues and then look to the market for the answers.

I hope this was interesting or helpful.