By Adam Eiseman
A common topic amongst real estate investors, passive and active alike, is in regards to the value of subject properties. In the spirit on conversation, I thought we'd delve deeper into the definition of the word, value. Webster's dictionary defines value as the following 7 descriptions:
1: a fair return or equivalent in goods, services, or money for something exchanged
2: the monetary worth of something : market price
3: relative worth, utility, or importance <a good value at the price> <the value of base stealing in baseball> <had nothing of value to say>
4: a numerical quantity that is assigned or is determined by calculation or measurement <let x take on positive values> <a value for the age of the earth>
5: the relative duration of a musical note
6a : relative lightness or darkness of a color : luminosity b : the relation of one part in a picture to another with respect to lightness and darkness
7: something (as a principle or quality) intrinsically valuable or desirable <sought material values instead of human values —
Clearly, when discussing the value of real estate, we can eliminate descriptions #5 and #6. So, let's begin with descriptions #2 and #3, which seems to be the focus of most real estate investors. The "monetary worth" of a property is typically determined in the investor community by comparable sales within a recent time frame and radius proximity. Certainly, I'd advise all investors to conduct their independent diligence regarding this approach towards value and encourage an investor to pay at or below "market value." We'll call this the common old age way of defining property value.
Next, let's walk through the implications in the real estate industry of descriptions #1 and #4. "A fair return" and "numerical quantity that is assigned or determined by calculation or measurement" broaches a new concept when considering property value. Dependant upon the goals of the real estate investor, a true definition of a "fair return" may vary. Take an investor looking to fix and flip a property in a 6 month period, their fair value is determined by a formula reliant on assuming the willingness of what a price primary home buyer to pay for that property. On the other side of the coin, an investor looking for long term buy and hold uses a completely different formula focused around monthly cash flow and return on investment percentage. I propose that this school of thought with variable interpretations of value is the new age way of defining property value.
Additionally, other factors play a role in determining the "fair return" as well, such as willingness to devote time to the investment. An investor on the price hunt, willing to devote hours and hours for dollars saved has a different "fair return" value than an investor willing to pay a premium for a done for you peace of mind investment. This leads us to the last description of value above #7. So, which of the above paragraphs best defines property value for real estate investors? The concept of intrinsic value may be the most accurate way to define the word value. Simply because of all of the variable goals, time limitations and focuses of investors worldwide, the intrinsic value of the investment makes the most sense.
Let's take a simple case study to bring the question of value to the forefront:
Property 123 Main St
Comparable Sales Average: $90,000
Company ABC Sales Price: $100,000
Monthly Cash Flow: $1,000
Return on Investment: 12%
*Company ABC guarantees all rental income*
Are you willing to pay the sales price of Company ABC or roll the dice and committing the time for hopes of a property close to the comparable sales avg? Neither answer is right or wrong, as we've determined that each person has a different definition of value.
So, what are your goals, priorities and focuses when acquiring real estate investments? After our discussion, that seems to be pinnacle before you determine how you define value. After all, property value at its simplest definition may be the numerical quantity one person is willing to commit to the investment.