Why do we care about a property's price per square foot?
I'm hoping you guys can help me with something I've been having a hard time wrapping my head around. I see commercial properties' price per square foot cited a lot. Why do we care about this, and not just the cap rate? Why does it matter how much you pay for something so long as the yield is sufficient to justify the investment?
[{"id": "dcm9spt", "text": "It is an easy way to quickly calculate its value. For example, 1,200sf retail space @ $30/sf = $3,000/month ($35/sf = $3,500/month). ", "replies": [], "depth": 1}, {"id": "dcmb6hd", "text": "Not that this is for-sure the reason but it can help you identify risk. If the cap rate is 8%, similar to the market, but price per square foot is $200/SF compared with most of the market near $100/SF, it would suggest higher risk investment with possibly above-market rent.", "replies": [{"id": "dcnpb45", "text": "Thank you.", "replies": [{"id": "dcs1zph", "text": "Agreed... if you're an outlier PSF it indicates more risk. Tied to that is the rent PSF from the tenants, if they're above market then there is a real risk of loss if they vacate and it's re-leased at lower rents. PSF provides a shortcut view of that risk. EG if the market is $17 PSF but the tenants are paying $25 PSF it feels great... until they vacate.", "replies": [{"id": "dctqtnz", "text": "Thanks. That really makes sense.", "replies": [], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "dcmh7fx", "text": "from a lender's perspective, it gives an apples to apples metric across properties.", "replies": [], "depth": 1}, {"id": "dcml7mr", "text": "Commercial rents are always in $/sq. ft. so it makes sense to list sales prices like that as well. Also if you're in constriction then renovation costs are often expressed as $/sq. ft. too. Makes a proforma very easy. ", "replies": [], "depth": 1}, {"id": "dcmr22e", "text": "If you have a new property you want to sell, you look at historical records of sales and square footage on similar properties close by and compute the Price per square foot. You then take that figure and multiply it by your property's square footage and then you have a near accurate sale price for your property.", "replies": [], "depth": 1}, {"id": "dcmwvrh", "text": "Because the yield is tied to so may factors, some that can be risky. For example, let's compare two Class A office buildings in your city's downtown. Well one of them is 10 stories, the other is 85 stories. Both are class A office space.\n\nA factor that would affect the yield are the top floors of the supertall building. Tenants will pay a premium for the view.\n\nBoth trade at 8 caps, but one is highly inflated on a price/SF basis. This indicates that something is going on (in this case, view premiums), that an investor should be aware of.", "replies": [{"id": "dcnpbjp", "text": "Thanks. So it's ultimately a measure of risk?", "replies": [{"id": "dco4guk", "text": "Not necessarly, just another means of comparison. If something is off between two comps, you will want to investigate", "replies": [], "depth": 3}, {"id": "dcs2660", "text": "Points to risk... easy benchmark vs other properties but not as an accurate measure of risk as cap rates. PSF also allows the investor to think of the investment versus replacement cost etc.", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "dcmxweb", "text": "That's the best metric for owner-occupied properties.  Dollars per SF is the Sales Comparison Approach, which should be reasonably similar to the Income Capitalization Approach.  If they're not close, it doesn't mean something is wrong, but it is at least unusual, meriting more analysis.", "replies": [], "depth": 1}, {"id": "dcnfw7u", "text": "There isn't one metric used in a vacuum to value a property. You want to look st multiple metrics to triangulate. You can give more weight to one vs another, but it's helpful to have more info. Price per pound helps put the value into perspective.", "replies": [], "depth": 1}, {"id": "dctuclp", "text": "I agree with most of what is said below, but I would also add it provides you context relative to cost to build new. We always try and buy below replacement cost. If a 10 year old building is $200 a foot but it cost $180 to build new - you should think carefully. ", "replies": [], "depth": 1}, {"id": "dk4o8it", "text": "It gives you a proportional perspective that otherwise couldnt be gleaned from looking at cap rates and overall price alone. You get a comparison that is measured in units, square feet, that can be compared regardless of size. However, this logic doesnt extend indefinitely. Obviously a 60,000 sq ft office will usually be priced, on a square foot basis, then a 200,000 sf office property, I think when the overall purchase sum becomes large enough, there can be a a slight discount for the property, on a square foot basis. ", "replies": [], "depth": 1}]