In the real estate industry, a common tool used by professionals is the price per square foot measurement. This metric allows real estate professionals the ability to compare and contrast properties based on a single number.
For example, a home that measures 1,500 square feet of heated living space that is also currently selling for $200,000 would have a price per square foot ($/SF) of 133.33.
While this single measurement can be easy to read, and it can be used across many properties, using price per square foot is one of the worst tools you can use to compare properties.
The price of a home, or a condo, or a townhouse, or any type of property is dependent upon several factors. Unlike most goods, a standard price does not exist for properties. This is due to the fact that no two properties are exactly alike. Properties may be similar in many ways, but no two properties are ever exactly the same.
If we look at the pricing of goods, say toilet paper, a unit price (the equivalent of a price per square foot) is an excellent tool to use when comparing goods and determining value of the good. If you find a 12-pack of toilet paper for $8.99 but find a 20-pack of the same brand and variety for $12.99, which one should you choose? If you use the unit price method you will find that each roll in the 12-pack costs 75 cents, while each roll in the 20-pack only costs 65 cents. In this example, the 20-pack toilet paper is a better value.
Why is this tool useful for comparing goods and not real estate? It is because goods are identical, and real estate property is not.
This poses a dilemma for those looking to sell real estate. There is no single way to set a price for a property to which everyone would agree as everyone has different preferences as to what is most important to them.
There are several methods of coming to a listing price and each involve either re-estimating the construction costs of the project, appraising the value of the land, or comparing other similar properties.
This final method of reaching a listing price for a property, comparing similar properties, is the most common method of reaching a listing price for a piece of property. It uses the concept of substitution, evaluating the cost of one property based on the similarity of another property.
With this comparison method, one must take into account several factors including size of home, bedrooms, bathrooms, garages, pools, age of the property, condition of the property, location of property. Since several factors are considered, it is not advisable to use only one statistical measure to evaluate a property.
Imagine comparing the retired basketball player Shaquille O’Neal to other players by only using his free throw percentage. Using only one metric would diminish his overall value. Similarly, if you only used Shaq’s points in the paint metric, you would wrongly infer that the rest of his game was equally powerful.
Here is an example scenario in which price per square foot might be used in the real estate industry and why it is wrong to use it.
Assume you have a fictional neighborhood with several different types of homes. Each home is a different size, different shape, with different numbers of bathrooms, bedrooms, garages, and pools. Each home has different levels of finishes, and each home was built at a different time. Clearly these properties are not identical.
To compare and contrast properties in this neighborhood, adjustments need to be added or subtracted to the other properties before coming to a conclusion on a price for your subject property. For example, if your subject property is a 3-bedroom, 2-bathroom home, you would need to subtract value from a 4-bedroom home but add value to a 2-bedroom home so each home is similar in nature.
If you used the price per square foot measurement before adjustments, your data would be skewed because each property is not the same. As we established earlier, trying to compare data of differing objects in not advisable. If you used the price per square foot measurement after adjustments, your $/SF figure would be rendered useless as you have already made adjustments to come to a price. You wouldn’t need further evaluation of data as you already have a price to compare.
While the price per square foot measurement seems like an easy and readily usable tool for comparing real estate property, it is not a worthwhile tool to use. Instead, there are several factors that need to be analyzed and evaluated before coming to a listing price. Like most things in life, there is no shortcut. Do not rely solely on a price per square foot measurement as your only method of comparison.
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