The Price Per Square Foot Trap - Revisited

I wrote this article last year and figured it is time to revisit this.

Originally posted August 3rd, 2018, by Rod Sager

So often I hear clients talking about the price per square foot on a residential listing. I even hear real estate agents talking that up. Why is this house $200/sf and this other one is 180/sf? Sometimes people are adamant about not paying more than "x" per square foot. My friends, in residential real estate, the price per square foot rarely matters as a comparative value. There are way too many other variables that affect the value of a residential property. Any property actually, but in residential there is a broad range of variables. The only time that price per square foot can really be comparative is if all other variables are identical or near identical.

For example to use the cliché of apples and oranges why is this Apple priced at 1.48 per lb and this Orange is .99 per lb? Why is a Red Delicious $2.99 per lb. and a Granny Smith is $1.99 per lb. Apparently Red Delicious Apples are in higher demand!

Well friends the only time this price per foot stat really matters is when you have two houses in the same neighborhood, same floor plan, same condition, same upgrades, hell, right next to each other in fact. Then if one is priced at a higher amount, you have to ask, why?

I think price per square foot is the most abused statistic in residential real estate. Ranch homes are always going to have a higher price per square foot. Small homes in expensive gated communities will have a higher P/SF than a large spacious home in a run down neighborhood. A brand new home will cost more per foot than an old house. Homes on acreage will often cost more because the land value is higher.

One simply cannot make any prudent decision based on price per square foot unless all these other variables match. Since that almost never happens, then we have to look at those other variables. In the end what really matters for a person buying a home that they intend to live in, is this: Do you like the house? Does it do what you need it to do? Can you afford it? If you answer yes to these, then you're done, pull the trigger and write it up!

Don't get caught up in price per square foot. I sold a 720 sf house last year for $255k all cash. It was nicely remodeled but nothing over the top. That is $354/sf. I sold a 4200 sf mansion with a breathtaking view of the Columbia River for 750k around the same time. That was only $179/sf and the house was decked to the nines with top grade trim, marble, soaring ceilings, the whole bit. Why such a dramatic difference. Simple, lots of variables. There is a massive demand for smaller affordable homes. Far more buyers than sellers. In the high end the opposite is true. Furthermore, there is a bit of the economy of scale when building a large house. Neighborhood plays a role as well but when comparing a very large house to a very small house you cross one of the rare times that location is not the number one variable. Demand is the number one variable here. When comparing similar homes across neighborhoods, location resumes its role as the primary variable driving values.

A 2000 sf home on a 10k lot next to a railroad yard might fetch $150/sf and the exact same house a few miles away in a nice neighborhood with a view might fetch $225/sf. Do not let the price per foot trap keep you from getting the right house. Understand that smaller one level homes will almost always have high per foot costs and larger homes on a small lot will have lower per foot costs. Here is a simplified example of why this is the case. Let's take a lot in a neighborhood that is 8,000 sf and fully ready to build. The city says the builder can put any house between 1200-2400 square feet, one or two levels. The following is an oversimplified hypothetical scenario:

The lot is 100k and the development costs (underground infrastructure, city required appurtenances, fees, permits, etc) are 35k. The builder is into this deal 135k before the first nail is hammered. The physical structure cost will vary depending on size and design dynamics. The landscaping and other costs will be more or less the same regardless, lets say 10k. So the hard costs fixed are 145k. Lets say the 1200 foot ranch costs 100k to build. That puts the net cost before marketing and other post build expenses at $245k Let's say the builder budgets 15% for marketing and other costs of sale (real estate commissions, taxes, staff, ads, etc). That makes the total cost of goods about $282k. Let's say builder makes a 10% profit. That makes the 1200 foot ranch home $309k. Now the same scenario with a larger and slightly more expensive 2400 sf two story trimmed out the same might cost 165k to build. Now the builder has a total cost of goods at 360k and a sales price at $395k. The cost per square foot on the ranch is $258/sf where as the equally built and trimmed 2400 foot home is only $165/sf.

There are many costs that are more or less fixed regardless of what type of house is put on the lot so the larger house is less expensive to build on a per/foot basis. The builder however makes only $28k profit on the little house where as he makes $36k on the larger house. The builder has a finite amount of land with which to build so he wants to maximize profit and thus larger homes become more profitable despite having a lower cost per square foot. The lack of new small homes puts even more pressure on the resale market for small homes and that is why you might find a 1940s 720 sf house at $354/sf. 

Landmark Condo Legislation Passed

The State of Washington recently passed a serious update to the 1989 Washington Condominium Act and subsequent law surrounding it. This new legislation takes effect on July 28 of this year. The new law or revisions to existing law depending on how you look at it, focuses on the broad legal language used in the past. It is designed to eliminate some of the frivolous suits brought against builders without destroying the basic safety net of law protecting condo owners when a project has serious flaws.

The language is the key. Prior to this new legislation, it was too easy to open suit for simple problems and now the state has used more clarifying language to identify serious issues rather than trivial ones. This new law should bode well for developers planning high-rise projects on Vancouver's amazing waterfront.

The real problem with all these stupid suits is the fact that they can take years to conclude and during that time units often become unfinancable leading to homeowners struggling to sell or refinance their units. Many condo owners over the years have been trapped during lengthy litigation. The revisions to Washington State law are intended to minimize these so that trivial suits are no longer filed against.

Let the construction begin...

Selling with Tenants Still In

Sometimes a landlord needs to sell off a rental property and sometimes they still have their tenants in when the decide to list. For some landlords that are carrying a loan on the property, they may need to have the rental income to maintain the operating costs on the property. Ideally have the tenant move out first and prepping the home for sale is going to yield the best price for the seller. But things are not always ideal.

For sellers keeping a tenant on through the listing there are many hurdles. First the tenant has a right to 24 hours notice before any showings (Washington State). The seller may want to make a written agreement with the tenant to cooperate with agents for showings and keep the property spiffy with a lower rent payment as the "carrot" of inducement during the listing period.

Tenants can also be notoriously unreliable when they know they're on the way out. This can lead to closing delays if they are unable to move out in time, difficulty in showing the property and other setbacks to selling.

I have found that a financial inducement to perform is usually pretty effective. Listing agents and buyer's agents should also council both parties to these potential side effects of a transaction for a property with existing tenants. Unless the new buyer wishes to take on the tenant, things may not flow as smoothly as a transaction without renters. In the end things tend to work out.

Sellers will almost certainly get a better price if they remove the tenants before listing and have a nice move-in ready property. Selling for $10-20k more could be worth eating a few $1500 monthly rent payments.

Stay Involved with your HOA

HOAs can be a great thing, but they can also digress into an ugly beast. Homeowners should never be apathetic about the HOA. Going to meetings and participating in HOA elections can be very important on those occasions where the association has to make tough decisions.

Sometimes homeowners will react in a knee-jerk fashion and call for a strict revision to rules that might be an overreaction that could lead to unnecessary turmoil. Homeowners that do not participate in the process can be left behind unwittingly.

Sometimes an elected HOA president might develop tendencies to overreach his or her authority. Homeowners are wise to vote out these unreasonable people. If things get really out of control there is legal action than can be brought against the HOA and if the problem centers around an individual, that person could find themselves in a great deal of legal trouble if they are found to have abused their power. The HOA is for the benefit of the community and each property owner should have an equal vote in any processes that HOA oversees.

Generally an HOA will be setup with a super-majority requirement for major rules changes such as banning rental properties or something severe like that. It all depends on the HOA's written bylaws. I have seen some require 75% approval and yet others with a simple majority.

When buying a home in a neighborhood with an HOA, always read through the HOA rules, guidelines, and bylaws to make sure you are comfortable with how things are controlled and how rules and regulations are both enforced and changed. 

When living in a single family detached neighborhood, the HOA should have modest regulatory authority. Of course condos have to be more strict since the individual owners of the units own only the space between the walls. The land and building structures are cooperatively owned by every one in the community.

I run into buyers that will not buy a home in an HOA and I feel that is a bit of an overreaction. A well written set of bylaws with limited control for the HOA can lead to higher property values and less of a decline in neighborhood conditions over time. Buyers just need to make the effort to read through the documents and maybe even have an attorney skim through if something looks out of sorts.

HOA's are great... until they're not ;) Due diligence is always the best course of action.

Great Market, a Few Holes Though

This market is starting to get sizzly again, but like the title above suggests, there are some holes. Most segments are seeing a little bit of a seller's advantage, but aside from the entry level sub $325k market, conditions are mostly neutral. 

There is this one anomaly however. Two story houses with 3-5 beds and 2200-2600 square feet, priced in the 400-500k range are in rather plentiful supply. Buyers actually can kick a few tires and even smack the price around a bit on a mid-priced multi-level house.

Builders are 'all in' on this price range and they are producing them in large quantities. This is dragging down the resale market in the size and price range. While the entry level, mid price single levels, and even some of the upper end ranges are smoking hot, this mid priced two story segment is favoring buyers right now.

The market is screaming for single level houses right now. But single level houses, particularly in the larger size ranges like 2000 plus SF require a larger lot to support the bigger 'footprint'. Builders are trying to stay in a price point that is affordable for enough people to support the development projects they are building. Land has become the most expensive element in our market and so a two story design allows builders to build more houses on the same amount of ground. So we are seeing this play out in the market as hundreds of new houses are coming available and many are priced in the $400-$500k range.

So if you are looking for a "value" in this market larger two story homes in that 400-500k range could be your ticket.