Hidden Factors When Calculating a Home's Value


Statistical analysis isn't only important in calculating the value of real estate in Silicon Valley, it's integral to choosing a starting point, whether buying or selling. 

One of the metrics at our disposal which comes up frequently is the cost per square foot of a particular property.  The "per square foot" number divides the total value of the transaction by how many square feet of space within buildings was purchased or rented.  That phrase "within buildings" is important. 

This quick-and-dirty metric lets my clients compare the relative costs of properties of different sizes and shapes located in different cities around the Bay Area (or the rest of the world for that matter).  And it's useful --- to a point. 

But misinterpreting this number often causes buyers to overpay, whether it's because they offer more than a property is worth, they don't account for hidden factors, or they take for granted the seller's valuation based loosely on a per square foot calculations for the most recent, relevant comparable.  Here is what to look out for in your analysis.

Avoiding Errors When Using Cost Per Square Foot Analysis

When you go to the grocery store, you'll find an assortment of meats and produce all measured and sold by the pound.  It's useful because you can develop an intuitive understanding of how much more on-the-vine tomatoes are going to be than separated ones or how good the filet mignon looks next to the flank steak.

But even though they're both measured by the pound, comparing steak to tomatoes is really comparing apples to oranges, even though all four are foods.  There are several common ways that per square foot analysis can be accidentally misused, and these are the ways I advise my clients to steer around them.

1)  Extrapolating Home Values

Here's a real life example exaggerated for effect.  The least expensive single-family home sold recently in Sunnyvale came in at $835 per square foot.  The most expensive was 2,855 square feet.  So using this type of analysis would result in a valuation of $2,383,925.  What was the actual number?  $1,405,000.

The most common way this error results is applying the median per square foot number to the home you're looking at.  One reason why I talk about the Median Home in my market reports is so that my clients can compare the class of home they're looking at with what's in the middle of the range.

When using per square foot analysis, it's critically important to use the closest comparable --- not necessarily closest in terms of location (though it may very well be), but one that could easily and almost exactly substitute for the home in question.  This analysis leads to the second most common misuse.

2)  Treating Square Footage as an Accurate Number

Real estate pricing depends on how the land is used (.pdf) and Silicon Valley is no exception.  Real estate commands the largest figures when put to its "highest and best use."  In economic terms, you've eliminated any opportunity cost associated with the use of the land by maximizing its utility.

But not all the square footage in a home is useful and calculating that space isn't an exact science.  Some listings will provide a number from the county assessor and some sellers will dispute the assessor's estimate --- which may be based on a diagram and not an actual survey of the home.  Other listings might provide the seller's opinion on the home's size.

With this in mind, let's compare two fictitious homes at $750 per square foot, one at 1,500 square feet and another at 1,501.  Could a seller justifiably price the larger home $750 higher?  Not at this level of precision.

3)  Treating All Space Equally

Besides, real estate is valued on how you can use it.  Homes with odd angles or plus-shaped rooms mean that there's less space to put furniture or host house guests with.  Stairwells and lengthy corridors are usually included in the space estimate, but provide no real utility above and beyond connecting rooms with each other. 

Additionally, some homes just "feel" larger than others because the space is well-organized.  This means you can get the same amount of utility from less space, and many times, pay less in the process.  Understanding your must-haves in a home and a neighborhood will help ensure you get the best deal: by doing so, my clients understand what they're willing to pay for, and what they won't. 

4)  Not Accounting for Land

By definition, this metric doesn't take into account the amount of land included with the property.  You might assume that the per square foot figure is lower if land isn't included.  Then again, in the calculation we did above, the most expensive home had a number of $492.  The least expensive condo (without any land) had a number of $471.  The two numbers are pretty close: what does that mean?

First, the comparison crosses levels, which means that the comparison doesn't make sense.  But let's say hypothetically that both came out to be $492.  Does that imply that the two are equally good values or that --- assuming no other information is available on these properties --- they're in the same area?  Nope, but if you knew they were both comparables, you could get some hints about what hidden, or even intangible, factors to look for.

Factors in a Home's Value That May Not Be Obvious

If all real estate factors could be boiled down to a commodity spec sheet, buying homes from Costco would be today's reality.  As it is, there are several factors that go into how much a home is worth that may not be easy to fill out in a form.  Here are some examples.

1)  Daylight.  There's no substitute.  More precisely, it would be very expensive to create your own light as bright as natural sunlight. 

2)  Privacy.  Complete transparency in real estate is a good thing, but that doesn't mean you have to live in a glass house.  People often trade-off privacy to live in an urban environment.  In a more residential area, people might live on a main road and trade-off total cost.

3)  Noise.  Road noise and trains are rarely seen as selling points when it comes to listing a property.  But when they come with public transportation or a short walk to restaurants, shopping and other things to do, the positives often overcome the negatives.

4)  Equipment Condition and Age.  Roofs, furnaces, air conditioning systems, ovens, flooring, cabinets: the list goes on.  Homes naturally decay over time and deferred maintenance is a common reason why one home doesn't sell for as much as the one next door.

5)  Easements.  Sometimes other people or companies are allowed to use portions of your property --- the electric company might have a pole on your land or there might be a driveway to a home behind yours.  These easements are documented but may interfere with what your plans are for your property.  Because it affects your freedom to use the land, it also affects the value.