Price per square foot is probably one of the most commonly-used measurement to compare home prices. It’s easy to calculate (price/total square footage), easy to understand, and it’s analogous to the same measurements for other goods we buy. The grocery store prices meat per pound, for example. The gas station prices gasoline per gallon. If you move across the country, transportation companies often charge on a weight basis. Dollar-based ratios are everywhere, so applying them to home sales makes some intuitive sense. 

But doing so can easily lead you astray, which is the topic of this article. There’s a major difference between say, the price per pound for a ground beef, the price per gallon of regular unleaded, and the price per square foot of a home. The first two are constant, the last one is not. 

What does that mean? If the price per pound of ground beef is $3.99, then 3 pounds will cost about $12.00, four pounds will cost about $16.00 and ten pounds will cost about $40.00. The next extra pound will cost exact the same as the previous one. Same with gasoline – the price for regular unleaded is $2.50 per gallon, four gallons will cost $10.00 and forty gallons will cost $40.00. Every gallon costs has the exact same price.

Price per square foot does not follow the same rule. The price per square foot falls as the number of square feet increases. So, we tend to see higher prices per square foot for smaller homes than for larger homes. In other words, we see an inverse relationship between price per square foot and size. In economic terms, we say that square footage has diminishing returns to price.

Do not interpret this as saying that more square footage won’t increase the value of the home. It almost surely will. Larger homes tend to cost more. But, larger homes will tend to cost less than smaller homes on a per-square-foot basis. Why is that? Why do we see diminishing returns?

Holding location constant, the price of the home should reflect, to some degree, its cost of construction. Some of that construction will include features like the foundation, sewage, major plumbing, major electrical, and so on. These improvements have to occur no matter how large the house, but once they’re completed, changes are relatively minor for say, a 2,000 square foot home vs. a 3,000 square foot home. 

In other words, the cost per square foot of building a home from scratch will be higher than the cost per square foot of adding, say, 200 square feet, because the major improvements will have already been completed. Moreover, homes generally only have one kitchen (maybe two), one garage, and maybe one main family room (again, maybe two, especially if the home has a basement). The additional square footage difference might come from just a larger footprint for the kitchen or family room, but more likely extra bedrooms or bathrooms. Those involve extra sheetrock, framing, some electrical, painting, and so on, but the cost of those improvements will be lower than the average cost of building a home.

The same concept applies to money itself, which we call the diminishing marginal value of the dollar. An extra $500 goes a long way for a family making $65,000 per year, but not as far as it would if that same family were making $500,000 per year. Each extra dollar is a smaller percentage of the total sum of money, just like every additional square foot of home represents a smaller and smaller percentage of a home size. If you start with a 2,000 square foot home, adding 200 square feet means increasing your home size by 10 percent. But adding an additional 200 square feet on top of that (2,200 plus 200) means you’re now only increasing the home size by 9 percent.

What does all this mean for you? When you’re comparing the price per square foot of homes, make sure you’re comparing apples to apples. In other words, compare the price per square foot of homes that have similar sizes in similar neighborhoods. Otherwise, if you’re a buyer, you risk either missing out on a good deal or overpaying. If you’re a seller, you might underprice your home, or overprice it and waste time having it sit on the market unsold.

Let’s show you want we mean. The graph below picks out several zip codes and plots the price per square foot by home size. To make the graph clearer, we limited the home sizes to 6,000 square feet or smaller. Each dot represents a home sale in 2024. The lines represent the trend (relationship) of price/square foot and home size.

Note that for three of the four zip codes, we see the relationship we expect. As the home size increases, the price per square foot decreases…

But wait – one of the zip codes, 84103, shows the opposite relationship! Price per square foot is increasing as the home size increases. What’s going on?? 

Remember above when we said “In other words, compare the price per square foot of homes that have similar sizes in similar neighborhoods”? Well, this is an example of what happens when you don’t do that. It’s also an example of the benefit from having a well-informed realtor, familiar with the area, to guide you in making the most of your home purchase, sale, or upgrade. Let’s look more closely at zip code 84103. 

We can make out two things:

(1) this zip code shows a large variation in price per square foot even for similar square footage. Large homes can vary from just over $200/sq.ft. to over $600 sq. ft. This tells us something very important (more on that in a minute).

(2) The graph give us the indication that two relationships might exist here, for (relatively) smaller vs. larger homes. Let’s look at homes larger and smaller than 3,500 square feet. 

Now we can see things more clearly. Homes smaller than about 3,500 square feet follow the expected relationship of diminishing value of added square footage. But larger homes do not! What’s the big takeaway here? Remember above when we said that the larger variation in price per square foot even for similarly-sized homes tells us something important? 

It does! It suggests that this zip code has some fully-upgraded homes priced accordingly. It also tells us that we can find some large homes that haven’t been upgraded yet and that might have some very strong upside potential. A well-informed prospective buyer or existing homeowner making the right, cost-effective upgrades, could turn their purchase into not only a dream home but also a strong investment.

That’s where Stairtop comes in. Our Upside Potential Rating (UPR) helps you cut through the uncertainty of home investment so you can make the most informed decision and get the most for your money. More on UPR in our next article.