Value investing in real estate investments – methods to be used
Value investing in real estate investments: Investing in real estate is no different from picking up the stocks on the security markets in terms of the analyzing by means of market fundamentals and other macro-economic conditions. Value investing in share market helps the real estate investors to make effective decisions. Billionaire investors like Warren buffet has been following value investing in making real estate investment decisions for decades. In this article we discuss how one can make use of the value investing principles in making real estate investment decisions.
Value investing is an investment strategy where stocks/properties that are priced less than their intrinsic values are selected to make the investments. By means of analyzing the fundamentals of the properties/stocks, one might arrive at the intrinsic value before making the final decision. The father of value investing Benjamin Graham has advocated that prices of stocks/properties in the real estate sector are irrationally influenced by the market conditions. Thus, the chances of them being priced at lower than their actual worth is present at times.
In determining the intrinsic value of the real estate properties, 2 methods are widely used. They are
Replacement Cost Method:
This method is often used for new development. One can estimate replacement cost of a real estate property by computing the estimated cost to develop the property and then comparing it with the amount at which it is currently priced in the market for sale. If the price is below the replacement cost then you better pick it up and buy it. In the long run when the price stabilizes, you can make profits by selling it.
Computing the replacement cost is a complex task that involves gathering construction-related estimates such as Site costs, consultation fees, legal fees and other finance costs. It is always better to get in touch with the real estate developers in the similar vicinity to obtain the best replacement cost estimates.
Net Present Value Method:
This is method where the estimated future cash flows of the property in place are brought to present value to determine the intrinsic worth. If the value so estimated is more than the current market price then it is better buy that property as it is undervalued in the current market according to the value investing principle. The interest that is used to discount the future estimated cash flows is ideally the one which that the investor can earn in the next best alternative investment.
Estimating the intrinsic value by best possible method is the key in making the decision. Choose the market and location where exactly you would want to invest and study the market trends in that area. Get in touch with the local real estate developers and understand their cost model. You can select the future selling price which is relatively in line with the then intrinsic value of the property. Ensure that your assumptions in computing the intrinsic value are rational and sound.