£/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 £/ft²?
Smaller properties still have similar costs for many of the expensive items in a property. For example, regardless of whether your flat is 800 ft² or 600 ft², 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 ft² and a wall perimeter of 60 ft, whereas a 30ft x 30ft room has a living area of 900 ft² 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 £/ft² 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 ft² house and we create three 600 ft² flats.
Kensington & Chelsea
Value of house: £2,850,000 (£1583 £/ft²)
Value of three 600 ft² flats = £3,200,000 (£1778/ft²)
Conversion costs = £350,000
The curve in this high-value area is very shallow with only a 12% premium /ft² between a flat of 600 ft² and a house of 1,800 ft².
Value of house: £800,000 (£444 £/ft²)
Value of three 600 ft² flats = £1,050,000 (£583/ft²)
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.
£/ft² 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.