Should You Consider
Replacement Value When You Buy Investment Real Estate
If you can buy investment
real estate at below replacement cost, is that a good deal?
In fact, is the cost to replace a building that you are considering
purchasing even relevant?
too often I see real estate being marketed at "below replacement cost"
as if this was some type of windfall that only happens once in a blue
moon. The fact is, the replacement cost of a property is for the most
part only relevant for insurance purposes. If the building is destroyed
by a fire for example, you need to know what it would cost (in today's
dollars) to rebuild. But as a method of determining market value when
you are looking to buy investment real estate, it has little worth.
if you ever have an appraisal done on commercial real estate, you will
see the "Cost Approach" typically included as one of the three
valuation methods employed by the appraiser. But the reality is, the
value of most real estate (both commercial and residential) is usually
derived from a "Sales Comparison Approach" or an "Income Approach".
take it one step further. You are considering buying an older house.
The one down the street that was almost identical (in age, size etc.)
sold for $300,000. But the asking price on the house you are looking at
is $350,000. The selling agent reassures you that at $350,000 you would
be getting a great deal because the cost to replace the house would be
Would you pay $350,000 for a house that based on
comparable sales is only worth $300,000. Of course not. The fact that
it would cost $400,000 to replace the home is irrelevant.
you are looking to buy investment real estate, the only value that
matters to you is today's market value. Figure that out first, and then
aim to negotiate a price well below that. If you can't, it is probably
time to move on to the next deal.
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