GUEST AUTHOR: Micheal W. Armentrout, VP AM Appraisals, Inc. Mike has been involved in full time real estate valuation since early 1992 and has experience in numerous Central Ohio markets.
As appraisers, we talk to realtors on a routine basis. Whether it’s to set up an appointment, verifying data or even just shooting the breeze, their insight can be invaluable as we analyze a property and its
market. There are however vastly different concepts between how realtors market properties and how appraisers observe market behavior. One such example is the use of price per square foot.
As an equation, price per square foot ($/SF) is simply the asking or selling price divided by the gross living area. It has become common lingo among many realtors but is it a reliable indicator of market reaction?
Now as an over-simplified reference point, we may not object to its use however it has been a growing rationale for agents, buyers, sellers and homeowners to establish value. I must admit when I hear the price per square foot argument as a means to value, my inner-appraiser starts to rev up into high gear. Shakes, convulsions and a flushed face are quickly tempered as I remember that we must educate if we
intend to explain the weaknesses of the price per square foot methodology.
The primary fault with $/SF is that it encompasses every feature of the property and not just gross living area. Only calculating the relationship between size and sales price ignores all the considerations a
potential buyer may make. If we were comparing two properties that were identical with the exception of size, then it is rational that the larger of the two may sell for more and thus the $/SF could be an accurate indicator. On the other hand, if we had two identical homes in terms of size but one had a
larger wooded lot and sold for more, the equation would not be as reliable. As properties have more dissimilar amenities and features, the less reliable it becomes as a function of indicating value. This is simply because other factors are not directly related to gross living area.
The same issue exists for price per acre in residential (non-agricultural) sites. While one acre may sell for a specified amount, that does not necessarily mean two acres will sell for twice what the one acre parcel did. There may be a premium for the excess or residual land but not based on a simple multiplier
That being said, price per square foot can be a tangible factor in considering cost. Builders and index providers such as Marshall & Swift do utilize $/SF for construction estimating but it is not a strongly supported methodology for market valuation. The grid technique that is commonly utilized in most appraisals (Fannie Mae 1004) as part of the Sales Comparison Approach allows individual analysis of key amenities for the subject and comparable properties. Market derived adjustments can then be made to comparables for superior or inferior features. The Sale Price/Gross Living Area field that is a part of the grid section is intended to be a general indication of the overall similarity of the subject to the selected comparables and not a basis for value conclusion.
A few years back, I had a call from a buyer who questioned my method for obtaining the gross living area (GLA) of a property he was in the process of purchasing. After explaining my physical measurements, Fannie Mae Seller Guidelines and ANSI standard Z765, he eventually backed out of the contract because the appraisal reflected a smaller GLA than it was marketed as. This seemed to go against all that we typically assume. He was in effect making his decision largely based on perceived GLA and not based on the features and amenities that the property offered. While he was an anomaly, it is true that buyers have varied motivations for their purchasing decisions.
If price per square foot was truly a common buyer consideration, then it is fair to expect that purchase offers would be made in these terms. Rather than a lump sum price, buyers would submit offers based on the square footage of the property and not a flat price that reflects all features.
If properties become widely marketed on the $/SF premise, is it possible that buyer behavior could evolve? It is unlikely that a simplistic math equation will change the diverse motivations of buyers but it could skew initial listing prices and then filter down through purchase offers. In any case, all parties involved in the real estate transaction process should have a basic understanding of motivation and reaction factors and not implement an overly simplistic formula for price determination.
AUTHOR: Micheal W. Armentrout, VP AM Appraisals, Inc. Mike has been involved in full time real estate valuation since early 1992 and has experience in numerous Central Ohio markets. He served as a staff appraiser at several local firms before forming AM Appraisals, Inc. with business partner J.M. Massey.