Replacement Cost: A Great Reality Check for Real Estate

Let's say that 20-unit building is 15,000 square feet, and to build that structure brand-new would cost $100/square foot - or $1.5 million. But, of course, the building isn't new. If you were to bring it up to the standards of new construction (for its class), let's say it would cost you $500,000. So that means, to stay below replacement cost, you'd want to buy it for less than $1 million.

In other words, if you spent $1 million on the property and $500,000 to upgrade it to brand-new status, you'd be spending no more than anyone else who was willing to construct a brand-new competitive building in the area. In fact, your cost would still be under theirs, as you would have gotten the land along with your purchase of the building.

Staying near or below replacement cost isn't always possible - especially in increasingly popular, higher-end neighborhoods. But in today's bear market, it is becoming easier in every kind of neighborhood.

And buying below replacement cost is not a guarantee of success. After all, if you buy into a neighborhood that's in serious decline, you may find no one willing to build there in future years at almost any cost. However, that is an extreme case. And you'd certainly be worse off if the neighborhood went into serious decline after you had paid far more than replacement cost.

So at the very least, buying near or below replacement cost will greatly reduce your risk on every type of real estate purchase. That - and your insistence on buying at prices that cash flow with a good yield - will help you be a shrewd buyer in a bear market.

Your success will not hinge on your ability to guess the bottom. Go ahead and make that judgment call along with others - including the best markets and neighborhoods to invest in. But get the numbers right first and buy cash flow, undervalued on a $/square foot basis and on a replacement cost basis, and your rare mistakes can still make you money in the long run... while your more frequent successes can make you (and your investors) a fortune much more quickly.

Tune into the live presentation by John Alexander of the Home Seller Assist program followed by a Q&A session each Tues and Wed at noon - Central. It all takes place at www.fastsellerloans.com, bring your questions.