Real estate value investors believe that real estate assets have an underlying intrinsic value that can be determined by analysis and evaluation. Opportunities for profitable investments become present when the purchase price of the asset is below the underlying intrinsic value of that asset. Value investors evaluate an opportunity in an investment by understanding the relationship between value and price. Thus, the essential task of a successful real estate value investor is to determine the intrinsic value to capitalize on inefficient market mispricing.

Replacement Cost

In determining the intrinsic value of real estate investment assets, there are two generally accepted practices used by fundamental investors today. The first is to determine the replacement cost of the investment asset to assess a general valuation. Adjustments are then made to the general valuation for the impact of depreciation on an older asset relative to new construction. In addition, an adjustment must be made for replacement rents versus new development rents. The end result is the intrinsic value of the investment asset.

Replacement cost numbers are typically generated on rough estimates of cost per square foot suggested by development and contractor organizations. When assessing replacement cost on an investment asset, contact two or three reputable developers or contractors, familiar with your market and product type, to obtain replacement cost estimates. Make sure your estimates are an apples-to-apples comparison that include standard costs such as: