Author: Michael Joyner, Chief Data Scientist @ Bricks&Logic
Introduction
£/square foot (sq.ft.) is a commonly used metric in the valuing of property. It is a measure of how much each square foot of the property is worth. However, what is less commonly understood is how £/sq. ft. changes depending on the size of the property, or how the local land value affects the rate of this change.
Example - Finsbury Park, London
An agent goes to a potential instruction and advises a value of £550,000 on a flat of 800 sqft. This implies a £/sqft. of £687. However, the potential client knows that a flat of 570 sqft sold for £455,000 recently just a few doors down. (implying a £/sqft of £798)
He therefore surmises that his flat should be worth 800 sqft. * £798/sqft = £638,000
The agent at this point needs to help the client understand how the size of a property impacts the £/sqft value. To do this they can show them a local £/sqft curve and explain how and why £/sqft. changes with size.
Why do smaller properties have a larger £/sqft?
Smaller properties still have similar costs for many of the expensive items in a property. For example, regardless of whether your flat is 800 sq.ft. or 600 sq.ft., you probably only have one kitchen and bathroom and they probably cost similar amounts. However, the additional cost of walls, roofs etc for the larger property is only a fraction of the internal area increase. Therefore the larger a property gets, the cheaper it is to construct on a per square foot of area basis.
Example: A 15ft x 15ft room has a living area of 225 sqft and a wall perimeter of 60 ft, whereas a 30ft x 30ft room has a living area of 900 sq. ft. and a wall perimeter of 120 ft. So in this simplified example, the larger room is four times bigger but only costs twice the amount to build.
Do all properties have the same shaped curve?
No, the higher the local land value, the less the £/sqft reduces as the property gets bigger. Why does this happen?
Normal markets tend to close out arbitrage opportunities. If you could make a lot of money converting houses into three flats, you would be releasing a lot of flats into the market, dropping their price and conversely be buying a lot of houses for conversion, increasing their price.
We can see the relationship between underlying land value, conversion costs and the shape (steepness/shallowness) of the curve in the following example where we look at two conversion projects, one in Kensington and the other in Waltham Forest.
In both cases we use a typical 1,800 sqft house and we create three 600 sqft flats.
Kensington & Chelsea
Value of house: £2,850,000 (£1583 £/sqft)
Value of three 600 sqft flats = £3,200,000 (£1778/sqft) Conversion costs = £350,000
The curve in this high-value area is very shallow with only a 12% premium /sqft between a flat of 600 sqft and a house of 1,800 sqft.
Waltham Forest
Value of house: £800,000 (£444 £/sqft)
Value of three 600 sqft flats = £1,050,000 (£583/sqft) Conversion Costs = £250,000
The curve in this lower value area is much steeper with a 31% premium on space for the flats.
For a developer to make money on a conversion they need to beat these example spreads by buying the house cheaper, selling the flats for more or saving on the conversion costs.
Graph showing the different shaped curves between an expensive (blue) and a cheaper (orange) location. (Kensington & Chelsea v Waltham Forest)
Conclusion
£/sq.ft. is a valuable metric in pricing property but must be used in context and as a curve and not a single point. Knowing the shape of the curve locally is an important factor in identifying development opportunities and in the use of comparable pricing.
About Bricks&Logic
Bricks&Logic are a data and price analysis website for UK residential property. Used by every segment of the market from Landlords/Sellers to Renters/Buyers, Agents and Research and Advisory, we are currently focusing on London and will launch a nationwide website in 2022.
Find out more at www.bricksandlogic.com
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The Property Voice - Insight from Richard Brown
Just this week, I was invited to speak on the future of real estate for a podcast. One of the themes that we discussed was the power of big data. This article showcases the usage and value of big data rather well, I think.
Many property developers will be aware of the ‘arbitrage play’ that is mentioned by the author here – i.e. convert a house into flats, for example. Under normal circumstances, we developers would need to find out the comparable sale values of flats in an area and then reverse engineer this back to the fair cost of acquisition of the house, after taking into account the cost of conversion, financing, transaction costs and developer profit.
However, not all flats are created equally! So, the £/sq.ft metric comes into play, as illustrated rather well. However, £/sq.ft is not always a straight line that is consistent based on property type and size, again as illustrated. This is where having good quality information at our fingertips can be of great help. It provides us a top level view to identify areas ripe for conversion projects, as illustrated by a sharply falling £/sq.ft metric curve. Then, it allows us to assess the relative end-values of the potential completed units as well, so that we can more accurately run our project numbers.
By being aware of this data, we can make better and more informed decisions, both at the area search level and also at the individual project level too.
Now then, I wonder what the GDV of 4 x 450 sq ft instead of 3 x 600 sq ft flats would work out like in these two examples…seems that I should head over to bricksandlogic.com to find out!