There are many ways to perform a home valuation and no matter which one you choose and how precise you are in your approach it will all come down to one thing…..it will all be subjective. Having said that how do you eliminate much as much of the guess work as you can and put a price on something you are willing to buy or someone is offering for sale? How is value defined?
Looking at the current number of homes for sale in Pasadena on any given day why do some sit unsold for months while others receive multiple offers and sell within days? Value is defined as what benefits are received compared to the price paid. Many people believed that the i-phone was expensive compared to other phones available for sale. However it offered new features those consumers found useful and therefore were willing to pay a premium to obtain.
Cost per Square Foot
One of the simplest ways to place a quick value on a property is to do a cost per square foot analysis. Take the sales price of a recent home divided by the square footage gives you the cost per square foot Now take that number and multiply it by the square foot of your house or one you are considering. Viola! An instant value, right?
Not exactly. In the world of home valuations seldom is anything linear. Consider the variables, neighborhood, view, lot size, floor plan, location, condition, traffic and upgrades, all of which will affect the cost per square foot. Take for instance two homes on the same street with comparable amenities. Home 1 is 1000 square feet and just sold for $500,000 or $500/sq ft. Home number 2 is next door and has 1500 square feet. Is the seller in the ballpark assuming a market price of $750,000 ($500 x 1500)? Probably not.
If dollar per square foot is your preferred method of home valuation, this is where the train jumps the track. It is an ideal calculation if two homes are alike, have the same lot size and are identical in condition. None of which actually seem to happen. I have always advocated that a smaller home will usually sell at a premium on a price per square foot basis compared to a larger home. The reasons being that the lot (parcel) cost is a major component of the overall cost of the home. Since some houses sit on a 6500 sq. ft. lot and some are on a 9500 sq. ft. lot we aren’t really dealing with similar comparisons. Secondly economies of scale come into home prices. Take the 1000 vs 1500 sq ft comparisons again. Building that 1000 sq ft home vs the first 1000 sq ft of the 1500 sq ft home would naturally consume the same resources and man power. The additional 500 sq ft would be much less expensive from a labor and material standpoint.
I wanted to validate this theory. I chose to look at Pasadena home prices in 2006 and 2009. I reviewed sale prices from January 1 – April 15, for each year, only analyzing single family residences, no condominiums or townhomes. I set up a chart with two different variables. On the left hand side you see the numbers from 1100 to 2000. These were the square foot ranges that the study was based upon. The values on the right hand side go from 0 to 900. This is the actual cost per square foot. The numbers along the bottom read from 1 to 109, representing the number of homes sold in this period, which were actually 113.
Reading from the left the first home was about 1975 sq ft (blue dot) and sold for approximately $400/sq ft. The numbers move down the line but correspond to each other in a straight up and down line. The conclusion certainly seems to support the theory, that as size (square feet) decreases, the cost (on a square foot basis) increases. Also remember what the market conditions were like in 2006. Home values were still increasing, based upon median prices, even though the market was beginning to slow.
2009
This year there have been about 72 home sales. It is much harder to make the same argument for increasing cost per square foot on smaller homes as was made in 2006. Plus the fluctuations in square foot prices seem to be much wider than they were in 2006. The trend line appears to be flat. Comparing the median cost per square foot of the homes used for the 2006 analysis the number was $465.46. This year it has declined to $346.74.
This year we have seen a greater number of lower priced homes and I think it is probably fair to say that more than a few of those have been foreclosures and short sales. Has this increased or decreased the utility of cost per square foot valuation? I think I would have to say that when we witness such wide swings in values as we currently have its difficult to say anything definitive. Actually maybe it does say something……the current housing market is very difficult to predict.
About Doug Willis
Good post and thanks for the number crunching. Price/sqft is my personal preference when placing valuations on homes, especially when generalizing the market. That said, the argument I’ve been trying to make on the prior post is that all valuation models, whether it be price/sqft or median home price, are plagued by the same uncertainties and variables.
I am glad you enjoyed it. I knew I was playing to a very well informed audience.
I also want to thank you for going through the trouble and posting this.
I personally see this data and draw a different conclusion than you – yes, there are wider swings in the price per square foot in the first 3 months of 2009 vs 2006, but I *do* believe that the average is significant.
To me, the measure of a good tool is whether it seems to validate the best of your personal experiences. Price per square foot, while as you say, is imperfect, is the the “most” *single* metric that can be used objectively.
As you pointed out, there are lots of subjective things which make homes different – but they are not good for *objective* statements. So the best thing, as a researcher you can do, is try to find the most useful *objective* measurements and then compare them to your *subjective* reality and see if they are good predictors.
Looking back over the history of sales by square foot by zipcode, so you are roughly comparing comparable neighborhoods vs. a diverse area like Pasadena, you can see that the trends of price per square foot correlate quite strongly in terms of peaks and valleys to the actual prices that the *same* house sold for.
I use propertyshark.com to do my analysis of that – it has price per square foot by zipcode going back to the 1980s and it’s very useful for tracking where we are, time-wise, in terms of housing prices.
As someone who has time and patience, I believe it is possible, and wise, for me to attempt to purchase near the 2-3 year time period where housing prices per square foot hit bottom in my desired zipcodes. Given that most housing cycles have a period of about 20 years (10 years top to bottom), I think being within 2-3 years is acceptable “error”. By my calculations looking at price per square foot, we have just passed the maximum value of housing by about 2 years. Using history as a guide, we’re about 8 years away from the bottom.
But I’m not content just hiding away for 8 years and hoping my analysis is correct – I like to keep tabs on the market and make sure that it’s still trending the way I predicted, and so far, $ per square foot within a zipcode has proven to be quite accurate.
I know you’re a busy guy, but perhaps you can do that same analysis but restrict it just to 91104, but widen the time period from 3 months to 6 months. I think perhaps you’ll see less variation in the average price per square foot.
Tim,
I will see what I can come up with for the 91104 zip code. As you probably know there is a lot of diversity in pricing here, from just east of Fair Oaks to about Altadena Dr. If I am understanding you correctly you are suggesting that the bottom of the market is still 8 years away?
Most everything I read says that at the very most we are two years away and that seems to be in the monority. I am seeing a tremendous amount of excitement right now. Perhaps its temporary, but who knows. My guess is based upon what I am seeing and hearing we are going to see prices actually increase over the next few months.
Interest rates are the key. If they go to 6% all bets are off, but as long as they stay around 5% people will be buying. My guess is purchase decisions are being made on one single issue “How much is my monthy payment going to be”
I think how far we are away from bottom depends largely on the return of easy money or returning to some level of pricing equilibrium between rents/home prices and incomes/home prices. Right now, renting in Pasadena is pretty cheap, and although there are a lot more properties available under $400K than previously, at that price PITI doesn’t really compare to rent… and that’s factoring 20% down.
I have many friends who have been excited about the drop in prices, but most of them don’t have 20% down, and those that are looking have had a difficult time getting qualified for mortgages for what they want, mainly due to income. Most of the affordable places are in North Pasadena. My friends that make more than $90K/year don’t want to live in North Pasadena, where the median income is close to a third to half of that (sorry if that sounds elitist).
An 8-year bottom does sound a bit long, but its not out of the realm of possibility. My opinion is that we’ll hit bottom in a couple of years, then go sideways for several more years. It will probably mimic the rest of the market’s massive deleveraging.