I worked in the construction management department of a bank for nine years.  In interacting with realtors, builders, and bank loan officers, the term “dollars per square foot” is often used to describe and differentiate between qualities of craftsmanship, levels of amenities, and geographical location of a particular new house under construction or for sale…all communicated through this one phrase.

During the last five years of working for this bank, I was given the task of evaluating new single-family construction loans in terms of the sufficiency of each construction budget line-item…lumber, framing labor, cabinets, HVAC, flooring, etc.

To create a more accurate method to evaluate each new loan, we produced “cost models” representing each geographical area by taking past recent completed loans in these areas, and dividing each budget line-item by the house square footage to create a bench-mark average consensus of the dollars per square foot for each construction activity and a global number for that geographical area…all in comparable units of dollars per square foot.

While calculating the square footage from the building plans from outside-of-wall to outside-of-wall, plus the internally, in-house agreed-upon convention of 50% for garages and balcony decks, we discovered that our total square foot calculations exceeded by about 10% the square footage given on the title page of the architectural plans.

For a construction management department within a lender evaluating the budgets for new single-family construction loans…getting the right dollars per square foot is important to avoid construction loans falling short of funds midway or at the end of the construction…requiring the borrower to come back to the bank for an increase called a “loan modification.”  Loan modifications add an increased element of risk to the overall bank loan portfolio…too many as a percentage of the total number of loans and the bank regulatory agency will note this negatively in its periodic audit…affecting the bank rating and stock value.

So why this 10% difference in calculating house square footage?  The architect uses “living space”…inside-of-wall to inside-of-wall…as the criteria for calculating the house square footage.

I have never heard the official reasoning behind this approach, but we assumed one reason is that living space is a number that the home buyer can evaluate that leaves out the thickness of exterior and interior walls…unusable space for living.  But another convenient reason in terms of cost to the builder and the home buyer is that an understated house square footage based on living space…reduces city building permit and plan check fees when cities and counties accept this living space square footage number given in the architectural plans.

Because the actual construction costs of concrete, lumber, drywall, painting, roofing, and stucco plastering extend from outside-of-wall to outside-of-wall…a square footage total understated by 10% using living space…will artificially inflate costs per square foot overall and for every budget line-item…making it appear there is more money per line-item in the budget than there is.  From a real estate sales standpoint this gives the house a better appraisal valuation in terms of construction costs and amenities.

In effect, an apples and oranges difference is created which inaccurately skews the talking-point cost appraisal number higher by 10%…unless the caveat is disclosed that the figure given is based on living space…which is almost never done…because few realtors, builders, or bankers make the distinction.

Only a construction person would bother to calculate the real square footage on the plans…rather than accept the architect’s “living space” square footage…and this would only be done for the purposes of uniformity and reality in comparing construction costs in the banking industry…for evaluating new construction loan budgets…and for other interests related to construction costs such as cost estimating.

In closing, an example would be helpful.  Using round numbers…assume a 3,000 square- foot size house in the year 2000 in East Manhattan Beach in Southern California on the inland side of Sepulveda Boulevard, with a lot price of $500,000 (knock-down the old existing house), a projected new house sales price of $1,100,000, and construction budget costs of $300,000.

If we use these figures…the construction costs are $100 per square foot.  The builder, realtor, and anyone else involved in the marketing and sale of the new house will use this number to communicate the quality and amenity level of the construction.

But what if, after calculating the square footage of the new house using the criterial of gross square footage plus the convention of 50% for garages and balconies (they have real costs) instead of living space…the actual square footage is 10% higher at 3,300 square feet.

This new larger number as the divisor in the denominator correspondingly produces numbers throughout the budget and overall that are smaller than derived using the architect’s square footage.  The construction costs per square foot are now $300,000/3,300 square feet… yielding $97/square foot…not $100/square foot.

In a new construction loan budget, if the number for the line-item HVAC is understated by 10% at $18,000 when it should be $19,800 per the cost model…along with every other budget line-item like cabinets, countertops, finish plumbing, and hard surface flooring, for examples, not only is the potential for the need for a loan modification increased by 10%, but the value of the product has been inflated artificially from $97 to $100, in an industry where these comparative numbers are important, valued, relied upon, and evaluated by the consumer.