Ryan Lundquist of Sacramento Appraisal Group has written a fantastic article explaining the importance of economies of scale and the ways we encounter situations all the time that tiny things costing more than a greater quantity of the same item. The Starbucks coffee analogy he employs is such a great illustration and I highly recommend checking his article out here The thing that’s surprising Ryan mentioned, however the problem is that we frequently do nationwide property and appraisal services not consider the economies of scale when we base our assumptions on the cost per square foot for residential properties.
One might think that a larger home costs more per square feet than a smaller one. In reality, when Ryan looked at market data for Sacramento County (California) residential market, he discovered it to be the case that “the larger the house, the less you tend to pay for each square foot.” This is an fascinating observation, but I’d like to add my thoughts about the subtleties which can complicate this understanding of the concept of economies of size as well as that law of diminishing return.
Three important factors:
- Ryan’s illustration assumes you’re looking at two houses of similar quality. For the Chicago market (as as in many other markets) the bigger homes are more expensive and have better finishings and, consequently, greater cost of construction. It is not wise to contrast a 4500 sq.ft. newly constructed home with a 1950’s ranch of 1200 square feet or a ranch to the 2000 sq square feet 1930’s English Tudor-style commercial real estate appraiser home that has important architectural details. They aren’t the same apples! To determine the true relation of square feet cost between properties The properties must be as similar to one in every way (location and quality, size of the lot and utility functions, etc.).
Additionally, we should take into account the fixed costs. Let’s say, for instance, we’re comparing two brand new homes constructed within the same community located in suburbia (this is based on actual figures). Both homes are similar in appearance and design, with four bedrooms and 2.1 bathrooms. One is 2500 square feet and is being sold for $250,000 ($100 per square foot) and the other 3100 square feet and is listed at $275,000. The costs of construction for both homes are based on fixed costs. Both houses have a cooking area 2.1 bathrooms, an HVAC unit, and so on.