Using Cost Per Square Foot When Evaluating an Investment Property

8

A few years ago I wrote my thesis on how the demand for different characteristics of housing (ie. beds, baths, condition, square footage, upgrades, location, etc) change in a good economy versus a bad economy. In beginning the research, I broke basic detached residential housing into 20 different characteristics in an effort to construct a statistical model. Not surprisingly, the square footage of a property was very highly correlated to the price of a property. In fact, square footage by itself was so highly correlated to price that it actually made it difficult to analyze the other characteristics; it essentially drowned out the other correlations. Ultimately, I ended up changing the dependent variable in my regression analysis to price per square foot (rather than price alone). This allowed me to analyze the other variables more effectively and how they contribute to the price per square foot of a particular property.

Since the time of this research, I have become more aware of the cost per square foot when buying an investment property.  Don’t get me wrong, I’m not running regression analysis against 20 variables on every property I purchase, but I do think that the cost per square foot is a very interesting data point.

Cost per Square Foot vs. Replacement Cost per Square Foot

It is especially interesting to look at the cost per square foot of an investment property compared to replacement cost per square foot. With home prices as low as they are right now, there is an unprecedented opportunity to buy property for much less than what it would cost to rebuild a property. Does this mean that any property below replacement cost is a good deal? Certainly not. However, in markets where the fundamentals are still strong and housing recovery is a reasonable expectation, buying property for much less than replacement cost is probably a good investment.  For example, in my market, the average cost to construct a new home is approximately $80/sf.  Based on the fact that my market is expected to grow over the next several years, I believe that buying and fixing property for $40/sf (half of the cost to construct) will make for a very good investment in the years to come.

With that said, it is also important to analyze price per square foot against comparable properties to determine whether or not a particular property is a good deal for an investor.  If the majority of the properties in a particular sub-market are being acquired and rehabbed for $60/sf, as an investor I would probably want to hold out for a property where there cost per square foot was less than this. Even though $60/sf is less than replacement cost, I still want to make sure my investment decision is competitive compared to the surrounding market.

When it comes to buying investment property, there is no right or wrong answer as it relates to square footage. I have found that bigger properties seem to rent quicker and are more attractive to would-be buyers. However, larger houses also come with a higher price tag for rehab and maintenance. Ultimately, if I’m going to buy an investment property, I’m going to make sure that my cost per square foot is very strong compared to the market. And chances are, in this market I’m going to buy the property for much less than what it would cost to build new.

Photo: Louise Docker

About Author

Ken Corsini

Ken Corsini G+ is the host of the Deal Farm Podcast (on iTunes) and has 10 years of full-time real estate investing experience. His company, Georgia Residential Partners buys and sells an average of 100 deals per year and has helped hundreds of investors around the country make great investments in the Atlanta market. Ken has a business degree from the University of Georgia and a Master Degree in Building Construction from Georgia Tech. He currently resides in Woodstock, Georgia with his wife and 3 children.

8 Comments

  1. I like to use price per sq. foot as one of many factors as well, but I would add that it is not always interchangable between homes. For example, if you find a home for sale at $50 per sq. ft. and it is 1500 sq. feet, you can not use that same price per sq. foot for a home with 2500 sq. feet. The larger the home, the price per sq. goes down and for a variety of factors.

  2. Cost per sq ft is pretty much nonsense unless you live in track development. If your home is in a New England community, especially coastal, you can have million dollar homes parked right next door to a house for 350k with the same square footage. The formula is flawed and is used by realtors who have no clue what the value of a home is. Realtors need to spend more time on the quality of the home and not the square footage. That would be like a gallery selling a painting by the square inch.

    • You are exactly right – cost per square foot is not a good method for comparison if there are big differences in housing stock for a particular area. However, for areas where housing stock is fairly uniform (i.e. age, condition, materials, etc), Cost/sf can be a great data point.

  3. Correct. I noted if you live in a track deveopment this formula can be used, but is it not archaic at this day and age? Any home owner can type in a search in Realtor.com and get a cost per sq ft market price for any area. Markets drive the housing sales and markets change from month to month, so if you are comparing a home that sold in the early spring to a home sale that was sold in December out of desperation — how can you give an honest representation of the value?
    What if one house smell like cat urine and one doesn’t? What is the apex factor for that? How do we know what the inspections were on the house prior the offer and sale? Perhaps there was many undocumented problems that caused the home sale to drop in price such as a mold in basement or severe electrical issues. This would be cause of a drastic drop on price, now realtors use this home as a comp driving home prices down. Is this good comparison or just bad evaluations?

    So, making a sale price on a previous sale is like throwing darts at wall.

    • Shane – all good points. You can definitely open a can of worms when you start talking about all the flaws associated with valuing properties these days. I wrote a blog not too long ago about my frustration with the appraisal system in general and how out of whack it is right now …. everybody seems to have different opinions about what is a true comp and what is not (which is why it’s not uncommon to see certified appraisals on the same house, done by different appraisers with HUGE differences in opinion of value)

Leave A Reply

Pair a profile with your post!

Create a Free Account

Or,


Log In Here

css.php