Summary

When investors purchase income property at a discount to replacement cost, they are probably, in fact, paying market value.

Market value takes into consideration the present state of the real estate, its location, the surrounding area, and the overall economy. The price paid is what the real estate is economically worth at the time of the purchase. This assumes that the price is not being artificially propped up with seller’s guarantees or tax incentives.

Purchasing real estate at a discount to replacement cost has a positive affect when construction starts result from real economics. Construction activity begins when the NOI increases to a level that offers attractive investment returns. Offsetting this increase is the fact that your older real estate has to compete with new real estate.
We have frequently asked many of those investors who purchased real estate at a 50% discount to replacement cost why they don’t turn around and sell the real estate for a quick 100% profit? That’s the math of buying at a 50% discount. Well, in 99% of the cases the answer is they can’t. In most instances, they could sell the real estate for approximately the same price they paid. More realistically, if the real estate is sold after a short holding period, the investor probably incurs a sizable loss (and that includes the 50% discount to replacement costs) when the transaction costs are added back.

The price you pay for the real estate you buy today will determine your future ROI. That’s an old real estate axiom, but a reliable one.

Financial economics determine today’s value and tomorrow’s ROI.

Buying income property at a discount to replacement cost can be akin to a self-inflicted financial wound. Buy your income property on the financial economics, not the replacement cost.

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