The Right and Wrong Way to Calculate Price per Square Foot
In an industry so obsessed with price per square foot, the math really needs to be done correctly.
I've been debating writing this blog post for a while. Why? Well, is it really in my best interest to correct agents when I see them giving incorrect information to their clients? I mean, if I overhear an agent using incorrect calculations when trying to arrive at a fair value for a condo, is it my place to correct them? I like to think a big part of the value I bring to clients is that I care about the math, and that I choose to do it correctly. Not everyone does.
Which brings me to this post.
It drives me absolutely crazy (and my wife can attest to this) when I see and hear agents quote price per square foot metrics that are just plain wrong. I'm not talking about instances where a listing incorrectly states the wrong square footage for a unit. That's a whole other discussion about the accuracy of what's reported on MLS.
I'm talking about price per square foot metrics on units with parking.
Every client I work with, especially investor clients, will quickly realize my obsession with price per square foot stats. It's the only true apples-to-apples comparison to say whether a unit is priced better or worse than another. And while it's not the only metric to consider, it should certainly be at the forefront of any analysis.
Let's take a step back for a minute. Calculating price per square foot should be simple:
If a 600 sq ft condo is listed for $600,000, the price per square foot is $1000/sq ft.
If a 500 sq ft condo is listed for $550,000, the price per square foot it $1100/sq ft.
Where a ton of agents get it wrong is calculating price per square for for units that include a parking spot.
Have you ever heard someone say "it's only $1000/sq ft, including parking". That makes me shudder. Here's what I see every day:
A 600 sq ft unit with parking, listed for $650,000 is being quoted as $1083/sq ft.
At first glance, sure, that sounds right. $650,000 divided by 600 sq ft.
But it's absolutely the incorrect way to analyze condos.
Here's why. A parking spot (and a locker for that matter), has a fixed value in a given building, regardless of the size of unit it's attached to. This is such a key aspect to analyzing condo pricing.
The price or value of a condo will increase or decrease depending on its size, but the value of the parking spot remains fixed. So to include the value of a fixed-value asset into a price per square foot analysis of a condo unit will skew the numbers disproportionately as the size of units vary.
Before quoting a price per square foot metric, you must first exclude the value of the parking spot.
In the example above, if parking is valued at $50,000 in this particular building, the price of the condo alone is actually $600,000, making the price per square foot exactly $1000/sq ft.
This is the correct way to quote price per square foot for condos.
I know a lot of people are probably thinking "sure, but if you compare two units with parking, then you don't have to go through deducting the value of parking, and you can just divide the prices by the sizes and you're done, right?"
Let's take an example that I've seen so many agents (including experienced, well known agents) use to value two units in the same building:
Condo A 550 sq ft, with parking, sold for $550,000.
Condo B 600 sq ft, with parking.
How much should this be valued at?
Here's what I hear every day:
"Well, Condo A is priced at $1000/sq ft, so that means the right value for Condo B is $600,000. 600 sq ft times $1000/sq ft, because that's what Condo A sold for: $1000/sq ft"
Seeing this type of incorrect analysis hurts my head.
Condo A did not sell for $1000/sq ft. Assuming parking is worth $50,000 here, Condo A, as in the unit itself, sold for ($550,000 - $50,000) = $500,000, which works out to $909/sq ft.
That's the metric to use when comparing values of similar units in this building.
Applying this to Condo B, it would make the value here ($909/sq ft x 600 sq ft) = $545,454 for the unit itself. Now we add back in the value of parking at $50,000 and we get to a value of $595,454 for the true value of Condo B with parking. Not $600,000.
Now I know what you're thinking: "Adil, what's the big deal? It's pretty much the same."
Well, I don't work in a "pretty much" world. Let's look at what happens as you get larger in scale:
Condo C, in the same building, is 800 sq ft and comes with parking.
If we use the "wrong" method of analysis and use $1000/sq ft, one would think the value of Condo C with parking would be $800,000.
But using the correct metric of $909/sq ft, the true value of Condo C itself, without attributing the fixed value of the parking spot, is $727,272.
Add back in parking and you get a true value of $777,272.
This is a far cry from the $800,000 value the "wrong" method gives us, and you can start to see why it becomes important to make the distinction between the fixed (parking) and variable (square footage) portions of the unit.
Now I've surely simplified things a bit by not attributing factors like diminishing returns on price per square foot as units increase in size, etc, but those factors only prove my point even further. Give me a buzz and we can chat about this, because it's what I love to do ;)
Simply including the value of a parking spot when calculating price per square foot will have an effect of making the metric seem greater than it truly is for smaller units, and so it becomes even more important to strip out this fixed value on lower priced, lower square footage units in order to do an accurate comparison.
To go a step further, in order to analyze price per square foot between units in different buildings, you now have to factor in the relative value of the parking spot in each respective building, strip that value out first from each respective unit, and then you can really talk about a true apples-to-apples comparison of price per square foot between buildings. If everyone is going to talk so much about numbers in real estate, we should be doing the correct math, right?
Here's a link to my last post where I went into detail about the relative value of parking spots and whether parking should be considered when buying an investment property:
Oh, and you know those websites that give you a quick snapshot of price per square foot values in a building, price trends, and recent sales? They absolutely do not distinguish between units that have sold with parking and without, so their price per square foot math is wrong and misleading. Sorry, but it is. And don't get me started about the way the media reports things...
So the next time you hear an agent do a price per square foot analysis and they say something like "it's only $1000/sq ft, including parking!", watch how they perform their math. Then hopefully you can quote this blog (written by a numbers-obsessed engineer-turned-Realtor), and you can show them how it's really done.
Your Toronto condo lover,
iPro Realty Ltd, Brokerage
Direct: 647-223-1679 (call/text)