Why the market value of investment real estate often comes back to the cost of replacement

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Most legacy real estate salespeople use comparable sales as a measure of value for real estate, but it can be a trap if you are a value investor. Here’s my opinion on how buyers should be valuing investment property instead.

Most people would argue they know how to value a property. There’s a basic format: You look at the property you like, look at prices for comparable properties, and estimate the value from there. In some cases, you might also include expected rental returns as part of your measure. While this may be the norm, it can also be a value trap.

In a booming market, everything could look cheap compared to the last sale, but it might be expensive in terms of replacement.

How to think about it is how much you paying per square metre relative to how much it costs to replace that property. If you think about it in that context, you’ve got a better chance of preserving the downside of your investment and capturing some of the upsides over time

Stay away from new developers’ stock unless the market is growing strongly and only buy from developers who have been decades in business. It is high risk business and a high percentage of developers go broke.

Better to look for buildings that have been built, and are preferably priced well below replacement cost, where the tenants are in place and the cash flows are known. Developers who guarantee rentals on new properties seldom preform as expected. The Developers often create an independent rental company that guartees the rental yield inflating the buildings value and then once the building is complete wind up the company leaving the investors with a worthless piece of paper.

Stay away from locations that could be adversily affected by global warming

In a weakening property market, now might be the time to get back to basics when global real estate investing.

Globally, the real estate market is incredibly diverse. It’s around $2.5 trillion of market opportunity.

You have your traditional sectors like rural, retail and office, and industrial. Still, it also encompasses exciting asset classes such as student accommodation, senior housing, self-storage and data storage. These are asset classes that are really interesting and pretty unique in the all market contexts, but also have a very powerful long-term global thematic setting behind them.

How to evaluate properties to invest in?

In most cases, the best way to think about real estate is to think about it relative to its replacement cost ie cost per m2. I think the big value trap or the go-to methodology for valuation in real estate for a lot of people is you look at a comparable sales only.

Residential Options

Residential real estate is a great example. 

You’re going to buy an apartment. The first thing you often hear asked of the saleperson is, “Well, what are the comparable sales?” You’re trying to triangulate around that. That leads you down the garden path because if the market’s super hot, everything looks cheap relative to the last sale. But everything could be absolutely overpriced.

What qualities do the properties you advice value investors to look for ?

The way we define investable real estate is real estate that’s been already built and tenanted and has a history of cash flows over a number of years. 

So we stay away from spectulative developers, not that that’s a good or a bad model; it’s not really rent-based; it’s transactional-based. And we also stay away from investing in real estate companies that rely on funds management income. ie REITS. Feels a little bit more like financial services than real estate.

We suggest looking for buildings that have been built, are preferably priced below replacement cost, where the tenants are in place and the cash flows are known and leases can be verified.

The other key is to buy real estate that has to have an alternative use. It might not be a better use, but it has to have an alternative. ie an office building might achieve a better yeild if converted into residential. A dairy farm might be better converted to growing nuts. ( less water demands )

What are your tips for real estate investors?

Do your homework. 

Open your mind to different sectors and geographies because those are usually the ones that are less picked over and offer the most interesting returns. Often there are twists to a normal market. For example in Argentina currently very low cost to build new using USD due the mismatch in local currency values which is why you see so many new buildings going up in Buenos Aires and a lot of major renovations.

When to sell ?

When the value of property gets out of sync with the international markets that are competing for the same buyers. Currently that would be Hong Kong.

When to buy?

When the value of property gets out of sync with the international markets that are competing for the same buyers. Currently that would be Buenos Aires, Sao Paulo (Sao Paulo is 55.1% less expensive than Seattle (without rent). Rent in Sao Paulo is, on average, 78.3% lower than in Seattle).

Contact the Gateway to South America team to learn about the best investment opportunities in the region. The company is a benchmark for foreign investors wishing to invest in Argentina, Brazil, Chile, Paraguay, Peru and Uruguay, providing expert advice on property acquisition and investment tours.

The Gateway Team – When You are Serious About Property


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About Geoffrey W W McRae

With a highly distinguished career spanning more than three decades across five different countries, New Zealander Geoffrey McRae has established himself as a leading authority on South American real estate, agricultural, and commercial matters. As the founder of Gateway to South America – a real estate consulting group specialising in six South American countries – Geoffrey has developed a reputation for discretion, expertise, and experience that has seen him represent some of the most prestigious clients in the region. His deep knowledge and experience of South American markets have placed him at the forefront of the industry and given him the opportunity to guide and advise with confidence and surety. His long and successful career – which continues to evolve and expand daily – is a testament to his talent, tenacity, and ambition.

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