Brokerage

Price-per-square-foot analysis: 4 tips for accurately pricing a home

Despite the haters, price-per-square-foot technique does hit home runs

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Takeaways:

  • When you are conducting a price-per-square-foot comparison, you must adhere to the 10 percent rule to be accurate.
  • Although upgrades generally make the home more salable, many add little or nothing to the actual value.
  • The best agents can price a property accurately without consulting the comparable sales.

Failure to properly price your listing right from the start can not only cause your listing to expire, it can cost your seller tens of thousands of dollars as well. If you’re not good at pricing properties correctly, there’s no better time to acquire this fundamental real estate success skill with price-per-square foot.

In a recent article on commissions, I referenced using price per square foot (PPSF) as a powerful tool for pricing properties correctly. A number of commenters took exception to that approach saying it was virtually useless. If this is the case, why do appraisers, tax collectors and commercial brokers still use this calculation?

Part of the reason agents need to master this approach is that it works exceptionally well with both sellers and buyers. For example, I spent a big part of my agent sales career representing banks with REOs. My other clients tended to be executives, business managers and international builders. Without exception, they always wanted the PPSF numbers.

So what is it about a PPSF analysis that doesn’t work for the commenters? The challenge with PPSF analyses is that to achieve accurate results, you must follow fundamental guidelines. Here’s how to use this powerful tool to achieve the most accurate results with your clients:

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1. Follow the 10 percent rule

The PPSF numbers posted on the MLS fail to take any other factors into consideration. When you are conducting a PPSF comparison, you must adhere to the 10 percent rule to be accurate. The 10 percent rule says that both the improvements and the square footage of the land must be within 10 percent of those of the subject property being evaluated. In other words, for a 2,000-square-foot house on a 6,000-square-foot lot, the comparable sales should be based upon properties with 1,800-2,200 square feet and with lot sizes from 5,400 to 6,600 square feet. The MLS numbers make no adjustment for lot size.

To illustrate this point, if you are selling in Southern California where the value is tied more to the land than to the size of the improvements, failure to consider usable lot size can completely throw off the calculations. In other parts of the country where the lot values are pretty homogeneous, price differences result from square-footage differences coupled with the quality of the improvements.

2. The truth about improvements

Several commenters noted that PPSF analysis doesn’t account for upgrades. However, the data shows that although upgrades generally make the home more salable, most add little or nothing to the actual value. Here’s why: How much are those beautiful new cherry wood cabinets worth when the buyer intends to rip them out in order to replace them with white contemporary European cabinetry?

There are a few exceptions to this rule of thumb: Upgrades that add square footage, such as an extra bedroom or an extra bath, normally increase the value. For example, if you convert a three-bedroom, one-bath into a four-bedroom, two bath, it usually increases the value of the property.

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3. Using the “thirds”

If you conduct PPSF analyses over an extended period of time, you will observe that the actual prices cluster into groups of approximately one-third each. While this can vary, the classification essentially remains the same.

Specifically, the top-price PPSF is limited to the properties in the best condition and best locations. The middle tier includes properties that are average for the area, i.e., the square footage, condition and lot size hover around the median values for the area. The bottom one-third includes properties where the condition, improvements and/or location are not comparable to the upper two-thirds.

Here’s how this works on a listing appointment: Let’s assume that the top-tier properties are selling from $170-$182 per square foot, the middle tier is selling from $145 to $162 per square foot, and the bottom tier ranges from $110-$133 per square foot. The current property comps are about $153 per foot. When the seller says they want the maximum price per foot, use the following script:

“Mr. and Mrs. Seller, the properties that are selling for $170-$182 per square foot are either brand-new or have been completely updated. Properties in this location with amenities similar to yours are currently selling from $145-$162 per foot.

“Consequently, if you want to sell for up to $182 per square foot, you will have to replace the kitchen, upgrade all the bathrooms and change all the dated fixtures to match what’s currently available in that price range. Otherwise, you can expect to sell at $145-$162 per square foot. It’s your house and your decision, what would you like to do: remodel or sell at a lower price now?”

4. Your market knowledge is still critical

PPSF analysis works best when you have a solid grounding in local values. The best agents can price a property accurately without consulting the comparable sales. For example, they may start with a PPSF analysis in a high-rise condo building but add an extra $10,000 per floor. Also, the south-facing city view may command a $20,000 premium while the water-facing north view commands a $50,000 premium.

There is no substitute for in-depth market knowledge. Nevertheless, PPSF analysis continues to be a powerfully persuasive tool not only for the clients, but just as often for lenders, CPAs and business managers. If you haven’t mastered this powerful tool, take the time to do so. Coupled with strong market knowledge, it can help you get the price right almost every time.

Bernice Ross, CEO of RealEstateCoach.com, is a national speaker, author and trainer with over 1,000 published articles and two best-selling real estate books. Learn about her training programs at RealEstateCoach.com/AgentTraining and RealEstateCoach.com/newagent.

Email Bernice Ross.