Investment Value: The Crux of the Deal

Investment value….

By definition, investment value has been defined as being specific to an investor, “based on that investor’s requirements, tax rate, and financing” (Section 5.3 CI 101 – Financial Analysis for Commercial Investment Real Estate).

What a buyer needs is not always going to be what a seller—or the listing agent–wants to hear in terms of a sales price. There is a natural tension between buyers and sellers in this respect, but it need not be an impossible situation. Approaching negotiations with the genuine intent to explore the issues would no doubt open up the possibility for discovering a third alternative. Ideally, within a third alternative is a solution that creates a transaction beneficial to both sides. When all the pieces align and everyone is getting what they need–and not necessarily what they want–a meeting of the minds becomes a realistic possibility.

Inflexibility is an opportunity cost

Let’s say we have a seller that overpaid for a property seven years ago; does this obligate the future buyer to accommodate the sellers’ expectation of value? On the other side of the table, let’s say we have a buyer that’s pretty hard-nosed about maintaining a 25% internal rate of return from all rental properties acquired. Let’s also say that the buyers’ situation would allow them to do very well at 15%, but it doesn’t matter. The buyer remains inflexible. They are happy to warm the benches on the sidelines as spectators looking on while real estate opportunities pass them by.

Is a disagreement of investment value holding you back?

It’s an unending surprise to see how many buyers and sellers believe that their way is the one true way of determining investment value. In their minds, they are right and everyone else is wrong. In reality, investment value is a subjective opinion of value that is unique to the individual investor, and each will have their own opinion of what that value is for them.  The income and expenses of a property are the main determining factors. There are a variety of considerations that affect these factors. Let’s take a look at operating expenses and how they can differ between an investment group and an individual owner.

Higher operating expenses means a lower investment value

The operating expenses of an investment group tend to be higher than an individual owner because of the increased administrative costs to oversee the management of the group itself, which is often formed for the sole purpose of holding the property.  The added administrative expense means a lower net operating income, which in turn, lowers the investment value for the group. The sellers’ opinion of value–while valid for the seller–does not come into play for the buyer. Buyers and sellers need to keep this in mind before writing each other off at the slightest disagreement about investment value.

Defensive positioning is counter-productive on so many levels.  

Primarily because it prevents the discovery of a third alternative.  Even in a hot market, properties can and will sit for years if buyers and sellers hold fast to a stubborn mindset, and a counter-productive holding pattern. In effect, they would be sitting on the sidelines as spectators and missing out on one of the greatest times in history to be a real estate investor.