Why Price per Square Foot Fails: The Pitfalls of a Flawed Valuation Approach
Updated: Jun 26
Price per square foot is one of the least accurate ways to value a home. So why is it utilized so much? Probably because it's easy to understand. Divide the price of some homes that just sold in the neighborhood and determine an average or median price per square foot. Then multiply your home's square feet by that figure. Voila! You're now an appraiser (kidding)! Many real estate professionals continue to use this method and get it wrong almost every time.
Let's take a look at this real-life example. The scatter chart below is based on an analysis of 68 single family detached sales over the last 12 months in my local high school district; that were built in the last 5 years; on 2-acre lots or smaller; and do not have a basement.
The median price per square foot is $188.47. However, the actual $ / square foot of these sales ranged from $118.08 to $311.22 / square foot.
Can you imagine what the spread would be if I had included all sales in the high school district? Here it is: 418 sales with a median price per square foot of $182.93 / square foot but the real range being $75 to $509 / square foot. Can you see how using the median price per square foot would be very dangerous in determining the value of your home accurately?
So, why did I decide to write on this topic today? Because after 17 years of appraising, not much surprises me, but I was really startled this week by a request for reconsideration of value for a new construction property (meaning they think my appraisal "came in low"). I was asked to review additional sales that had square footage prices "in excess of the $XXX/sf needed to support our contractual purchase price". What?!?
Translation: A real estate professional asked me to select comparable sales based on the same price per square foot they needed me to value their subject. Naturally, I was provided two "comparable sales" from inside the subject's subdivision that met their criteria of price per square foot. However, they were over 25% smaller than the subject. But whoa Nelly! Here's the deal. All things equal, smaller houses tend to have a higher price per square foot. Adding extra square footage will lower your overall price per square foot. For example, compare a 1000 square foot ranch house to a 2-story 2000 square foot house. I don't need two foundations or two roofs for the 2000 square foot house, do I?
The other sales provided were over 5 miles away in superior subdivisions with superior location and amenities. This is called "chasing a value" since we already had plenty of comparable sales right there in the subject's subdivision.
So what happened? The two smaller subdivision sales were added to my analysis and they just contributed to further solidifying my initial value opinion. And there went 2 hours of my life trying to explain something in writing that no one wanted to hear; not the agents, not the builder, not the loan officer, and probably not even the buyer who would have paid about $50,000 more than the house was worth. Yup, even the buyer is probably mad. Sadly, this is the time an agent should be negotiating a better price for you, Mr. or Ms. Buyer, not advocating for their commission at your expense by trashing the appraisal and/or the appraiser, or jumping to a new lender and ordering a new rush appraisal hoping the next appraiser will be less thorough or is somehow in someone's pocket.
Appraisers do not value property via price per square foot. Buyers and sellers need to understand that appraisers are probably the only ones in the transaction who have no motivation to 'fudge the numbers'. We are paid a flat fee for an unbiased opinion of value whether or not the deal closes. We advocate for no one; we don't receive a commission. Our job is to protect the public trust. This means a credible value opinion, by default, helps protect buyers from overpaying, lenders from over-lending, and the real estate market from crashing and burning.
Please remember these three things:
It is not a real estate appraiser's job to close your deal. It's their job to provide a credible opinion of value.
There is no adjustment for an uninformed buyer or seller.
Don't let someone value your house using the sales price per square foot method.
Sellers, make sure your property is properly valued so you set a realistic listing price that won't leave money on the table being too low and won't leave your listing languishing on the market because the price is too high. (Houses that are on the market longer than normal statistically almost always sell for less than their fair market value).
Why does this method of valuation fall flat? Here are some of the important reasons:
Ignoring Property Features & Overlooking Property Improvements Even if an agent includes other finished areas in the equation, it still treats all square footage equally, disregarding variations in layout, design, amenities, and overall condition. Two houses with the same square footage may have entirely different interior finishes or additional features like swimming pools or updated kitchens.
Price per square foot fails to acknowledge upgrades, treating all square footage equally regardless of improvements made. By solely relying on price per square foot, you may overlook these crucial differentiators that significantly impact a property's value. Do you think the same price per square foot would be accurate after this renovation?
Location Location Location! Real estate experts often stress the significance of location in determining property value. However, price per square foot fails to take this vital factor into account. It assumes that the value of square footage remains constant across different neighborhoods, disregarding variations in access to amenities, school districts, and proximity to transportation. It also is not accounting for site size and differences such as golf front, lake front, ocean front, or that a property is sitting directly under a cell tower or high voltage lines.
Valuing real estate is a complex process that involves numerous factors beyond square footage. If everything is equal then price per square foot would work in theory, but this is very rarely the case. Other dubious methods are Zillow and tax assessor value. (Speaking of which, if you want to appeal your property tax valuation in Coweta County time is running out. You only have 45 days to start the process from the post date on their letter. Call me if you need assistance with that).
In summary, real estate professionals should not be lazy and should learn to implement more sophisticated reliable methods of valuation, and if you don't want to learn more accurate methods, then hire someone who can do it for you. Price per square foot is an oversimplified and inadequate method of valuation in almost every circumstance and should go the way of the dinosaur.