Valuation: Price Per Square Foot is only Part of the Answer
One of the mental traps I see that can foul up real estate expectations across Silicon Valley is the over emphasis placed on “price per square foot“. Here’s where the internet can seriously mislead people into thinking they understand home values more than they do, resulting in botched negotiations, frustration and disappointment. So let’s talk about it.
As one factor among many, it’s completely fair to include the price per SF when trying to determine what a home’s probable market value ought to be. (Remember, too, that a house, condo or townhouse isn’t worth one exact number, but a range – because the terms involved also impact the sales price.) Although price per square foot is one way of finding approximate value, often is not the best, especially if you use it alone, because there are other factors besides the square footage of the house. Here are some of the other factors that can mess up that valuation based on price per SF alone:
- precise location (view, proximity to something undesireable)
- lot size
- lot shape & access (flag lots may sell for less than homes directly on the street)
- whether the house is below or above grade/street level (most people don’t prefer being down from the street)
- back yard size
- amount of remodeling (and how recently it happened, whether with permits/finals)
- care for the home
- additons vs original square footage
- whether the street is a good one or full of parked cars & RVs
- sale type – regular vs distressed
- landscaping (especially “hardscaping” – patios, pools, summer kitchens etc.)
- amount of down payment
- whether it’s all cash, conventional financing or if the seller carries a note
- whether there were multiple offers soon after it hit the market or if it was one offer after languishing for weeks or months
The variance from “all original” to “all remodeled” alone can swing value 10% – 20% in the San Jose area. Add to that other factors and the divergence in value can be much, much greater.
Additionally, smaller homes tend to sell for more on a per square footage basis than larger houses. The reason why is that kitchens and bathrooms are the most expensive rooms, but often there is just 1 kitchen and a similar number of baths with smaller vs larger homes. Even if the properties are comparable in many ways, a 10% difference in square footage can make the price per SF very wrong.
What about new construction?
In a tract neighborhood of NEW HOMES, if the locations are similar and finishes are similar (no upgrades), there’s a better shot of the price per SF being useful information. Many new homes, though, offer a completed home with basic finishes, and the buyer must opt for upgrades such as adding a fireplace with custom mantle to the family room or master bedroom, better appliances or counter tops to kitchen and baths, etc. Further, some new homes have basements and it’s possible that they may not be included in the square footage – and yet, of course, they may have immense value!
So even with tract homes, there are lots of caveats. Additionally, the older a home gets, the less likely this approach is to be accurate because some owners will remodel their home every 10-15 years and others won’t do a thing, not even basic maintenance, and the home will be “tired”( at best) very soon.
Online and automatic valuations
Often when home buyers look at Silicon Valley properties for sale they compare the list prices via online valuations. The difficulty is that the “auto-comp” figures are often wrong because they are based primarily, if not exclusively, on the “price per square foot” of the house’s listing. The online valuations often pick the middle of the viable range between “total fixer, probably needs to be demo’d” to “completely remodeled or brand new home”. Most of the time, the “range” is about 10 – 15% from fixer to fixed, so most of the time, the online valuation will be right in the middle with a 5% swing either way. But some of these sites (if you read their disclaimers) say that they are within 80% of market value most of the time. That’s not too accurate.
Let’s use round numbers to make this easy. Let’s say that the online real estate pricing says that a home is probably worth $1 million dollars. It might be that the actual pricing range goes anywhere from $900,000 to $1,100,000, but the virtual pricing tools don’t know if the home is next to high voltage lines, a busy road, is in the lesser school district, is remodeled or what. Or, conversely, if it’s a short sale, has been a rental property that got totally trashed, or has terrible terrible neighbors in the immediate vicinity who have garage sales on a weekly basis and need safari gear to get through their front yard. The true market value could be 5-10% higher or lower. It just depends.
So please take these things with a grain of salt. If you look at the online pricing and decide it’s correct but the house you’re buying is in a lesser location or in worse condition, you’ll overpay. And if it’s better, you’ll be too low and will wreck your odds of succeeding. Don’t forget to include market heat when trying to determine the likely selling price of the home you want. If similar homes are getting multiple offers and selling 5% or more over list, then the sale from 3 months ago is only old news, not today’s prices. In those cases, if you only rely on comps, you will find that you miss the mark every time. Home buyers who lowball their offers in a rapidly appreciating market will find that an expensive mistake to make, with the biggest risk being that they could even price themselves out of the market entirely.
My suggestion is to hire a good Realtor who can assist you with pinpointing the pricing, whether you are buying or selling, so that you can negotiate competitively and get the best deal you can for your home. I don’t mean buyers hiring the listing agent, either. When you do that, the agent also represents the seller and may be inclined to fight just for the other side – or for the highest price. Get your own real estate sales person who’s in your corner, helping you to evaluate properties and market value, and who will provide you good counsel all the way through the shopping, contract writing, negotiations, inspections, closing and beyond. There’s no reason to go it alone, and in fact doing so could cost you more in the long run.
For more reading on the same topic:
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(all data current as of 5/26/2016)
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