Replacement Cost Approach to Finding Intrinsic Value With Your Real Estate Investments

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 value investor is to determine the intrinsic value to capitalize on inefficient market mispricing.

In determining the intrinsic value of 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:

  • Hard Costs (Site, building, parking)
  • Soft Costs (Third party consultants, permits & fees)
  • Contingency Costs
  • Land Cost
  • Fees (Developer, construction, profit)
  • Marketing & Leasing Costs
  • Financing Costs

Finding a property’s intrinsic value using the replacement cost approach is used most often in the industry. The current industry replacement cost for a particular market and product type gives investors a baseline for valuation purposes. For example, let’s look at a typical cycle.

The economy is coming out of a recession, and demand for residential and commercial real estate is increasing. The increase necessitates the need for more housing units and commercial space to accommodate the growth. A house that cost $100,000 to build and that sells to a buyer for $120,000 creates a profit of $20,000. As the economy continues to expand and grow, replacement cost may increase to $110,000 (increase in land and building costs) and selling prices may increase to $150,000, creating a $40,000 profit.

As the economy overheats and demand starts to fall, fewer buyers are available to purchase, causing home prices to fall. We enter a recession and the market is flooded with homeowners and home builders trying to sell their huge inventory of homes to fewer buyers, causing home prices to fall even farther. The replacement cost of a home now drops to $90,000 (lower land prices and cheaper commodities) and selling prices have dropped to $70,000. When the economy begins to pick up again, home prices increase as the large inventory of homes for sale decreases.

The best time to be a buyer of homes is when the replacement cost to build a home is above the selling price. Buyers can buy homes lower than it cost to build a new home creating value. If a buyer bought a home for $70,000 and the replacement cost (intrinsic value) is $90,000, then the buyer has captured, at least, $20,000 of value. When the economy picks back up, home prices need to get above $90,000 (the cost to build a home) to make a profit.

The rule of thumb is to be a buyer when prices fall below replacement cost, and a builder when prices get above replacement cost. Therefore, replacement cost is the line in the sand (baseline). As a real estate value investor, you dream of the days when prices fall below replacement cost because value opportunities are everywhere.

Real Estate SEO (Search Engine Optimization): Making a Smart Choice

As a real estate professional, you qualify as a prime prospect for most companies
offering real estate SEO (search engine optimization) services.

You want more sales and more listings and they want you to
believe that they can give that to you.

If you haven’t already gotten calls, emails or letters from a few real estate SEO
companies telling you that they can get your real estate website into the top ten of
this or that search engine… get ready, because they’re coming…

A lot of real estate professionals struggle with whether or not to make an
investment in a company to manage their SEO campaign.

Will it be worth your investment? Will you get burned?

There is no right decision, but there are smart ones and dumb ones.

Here are a few things to think about as you make your decision about real estate

1. SEO is just one piece of the internet marketing puzzle. Hiring a
company to optimize your real estate website for the search engines is not
necessarily a bad thing, just understand that it is only one part of your internet
marketing plan. Focusing too much on SEO leaves a lot of money on the table.
Having good rankings makes it seem like your website will be a successful generator
or real estate leads. Not so.

In the past, search engine optimization WAS pretty much synonymous with internet
marketing. SEO WAS marketing on the internet – that was all you needed to do to
get noticed and get leads. Times are different now.

Understand that your marketing has to be right FIRST, before you even set foot onto
the internet and spend time and money bringing prospects to your real estate

That means you need to identify your market, create a message suited perfectly for
them and deliver that message with the media that they are known to respond to.

That must be done before you even think about SEO.


2. There are no SEO guarantees. Many SEO companies that are out there
cold-calling realtor lists often guarantee results or give the impression that there is
some guarantee of results.

There are no guarantees. Results-based guarantees from a Search Engine
Optimization company are a good sign for you to run the other way.

Don’t even waste your time talking to them.


3. Listen to exactly what the company you are speaking with is offering.
Most SEO companies that call you will make bold promises about improving the
rankings of your website. Many of them are very good at what they do. Sounds
simple enough, right?

But what exactly is your goal – Good rankings or more real estate business? Don’t
get caught up in the myth that better rankings = more sales or more leads or
listings. Better rankings equals better rankings. That’s it.

In a nutshell, know that SEO is important and good search engine rankings are
important… but SEO is not a silver-bullet for your real estate business. It will not fix
your marketing and although a well optimized real estate website might bring a
flood of prospects to your door, what good is it if they never knock and ask to come


4. Marketing is marketing is marketing… Always has been, always will be.
The internet hasn’t changed anything about that. What the internet does do is give
you a very efficient delivery system to use for your marketing message.

Whether or not you seek outside help for your internet marketing campaign, the
important thing to remember is that you don’t abdicate responsibility for your own
marketing by “outsourcing” it. Outsourcing your own marketing, even on the
internet, is not a smart decision. After all, marketing is by far the most leveraged
activity you can possible engage in.

Marketing IS the business you are in.

You are the mastermind. You come up with the plan… THEN you hire someone to
do the implementation.