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