Investing Strategy & Tips
How To Get Good Value For Your Investment Part I
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Oct 24, 2005, 15:53

How To Get Good Value For Your Investment Part I

Selecting a good investment is basically a problem of making sure you'll get good value for your investment dollar. But how do you figure value? How do you know hen a buy is good, or when it's overpriced? This comes down t deciding how much a specific piece of real estate is worth.

There are three basic ways to figure the value of income property. If you look at all three approaches before making up your mind, you're least likely to go wrong.

These three methods are (1) the comparison approach, (2) the replacement-cost approach, (3) the income approach.

Each has strengths and weaknesses. Just remember that valuing real estate is an inexact science at best. No tow appraisers, even if they use the same approaches, are likely to come out with exactly the same answer. But this is the kind of situation where three heads are better than one.

The comparison approach is the best from some standpoints because you can get down to the finest details if you want to. It makes an item-by-item comparison of the good and bad features of several properties in the same general neighborhood. At least one of these properties is, naturally, a property you're thinking of buying. The idea is not to pay more for it than others are paying for nearby properties, all similarities and differences considered.

Let's say you want to use this comparison approach to value a specific property, or to choose the best buy among several. You start by choosing one property, or one kind of property, in which you might want to invest. Then you search through the neighborhood for other pieces of real estate that fit the same general description as closely as possible.

The reason I say "some general description" is that the more similar the properties are, the more easily you can compare them. There'll be fewer questions of taste and opinion. So don't try to compare single-family homes with duplexes, or a garden-court apartment house with a ten-story high-rise. If you're thinking of buying a forty- or fifty-unit apartment complex, look primarily at other apartment complexes of that size.

I've stresses that the properties you compare should all be in the same neighborhood. The neighborhood makes a big difference in property values. One apartment house in a desirable area may be a good buy at $250,000 while an identical building a few blocks away may be a white elephant at $150,000 because of a difference in surroundings. Unless you confine your comparisons to neighborhoods that appear to be about equal, you may be badly fooled.

If you're not sure whether properties you want to compare are really in the same "neighborhood", go talk to a few local real estate people or the nearest savings and loan association. They can usually give you a clear idea of the boundaries at which values change.

You can use the comparison approach to paint a broad-brush picture for yourself, or to make a sharp-pencil diagram. It depends on the number of properties you compare. As in any sampling process, the bigger the same, the more reliable. If you get data on six or eight comparable properties, you'll see a clearer sketch of what each is worth than if you look at only two or three.

Okay, so now you've picked out a  list of comparable properties. You're ready for the next big step, which is to size up the desirable and undesirable features of each. To find out what these are, walk in as a prospective renter - or even as a prospective buyer - and ask to see one or more the units.

One building may have unusually convenient floor plans, while another with an awkward floor plan may contain the most closet space and the best kitchens. A third may be the only one with fireplaces or an intercom system. A fourth may be the only one without elevators or laundry facilities. How do you weigh all these haves and have-nots? How do you figure out which property is the best buy on balance?

Do you try to compare the good and bad points of every property against those of all the others? No. That way lies madness, or at least hopeless confusion.

Instead, you pick one property more or less at random, and measure all the others against it. You could pick the one you're most excited about, or you could pick one that was recently sold. You could close your eyes and pick one by throwing darts at a map.  It doesn't matter, because we don't need a precise fix on the value of the property you choose. We're just going to estimate how much more, or less, each of the other properties is worth by comparison with the property picked as a standard.

The term we use for any property chosen as a standard against which to value others is "subject property". Maybe you think we'll be merely shadowboxing if we don't know how much this subject property is worth. But just wait. As we go along, you'll see that we're operating like a gunnery officer getting the range. All we need is a rough approximation to start with.

If the subject property has recently changed hands, you can start with its sales price (which you should be able to get from almost any broker thereabouts). If the property is listed for sale, the asking price will do nicely, and don't worry if this price tag is way out of line. Asking prices are based on personal quirks that range from greed through desperation to sheer stupidity. They may be far higher or lower than true value. But they're as good as any other figure to start from when you're using the comparison approach to valuing properties.

If the property hasn't been sold recently and isn't listed for sale, ask somebody knowledgeable to give you an offhand opinion if necessary. Just get a number - preferably reasonable, of course, but not necessarily so. You could start by saying that the subject property is worth $10 million, and you'd still get a good idea of which of the properties you're comparing is the most desirable investment for you.