Property valuation not close to Asking price?

3 Replies

I'm new. Looking at a couple of properties and the valuation based on income information, expenses desired cap rate is giving a property value that is way off from asking price (mkt?) like a couple hundred thousand. Is this common? How do you approach these was the calculated value I believe should be closer to what you pay?

Hello Vince and welcome. You should pay what something is worth, the asking price is irrelevant. Yes, it is very common for sellers to put property on the market with wishful numbers. It's also common for buyers to overpay for real estate. So you should be focused on staying disciplined to your investment criteria, whatever that may be. Good luck! 

This is a good question. It is hard to give you specifics without the actual numbers you are referencing, but in general for a long-term play you want to quantify the intrinsic value of the asset. 

One very subtle concept that is easy to struggle with is the cap rate. The cap rate is not what level of return you are willing to accept, it is the level of return that the market currently demands to deploy capital. In other words, if you desire a 10% cap rate for an asset it may or may not be relevant because if the general market is willing to purchase at a 6% cap rate you will be outbid (assuming the market is efficient). 

That said, the market cap rate is not necessarily a proxy for the intrinsic value either. If the market gets overheated (which is happening now in most markets), cap rates will compress enough that the market begins overpaying. You start running up on real downside risk in these types of situations. 

If I were in your shoes, I would dig deep into the numbers and try to understand how the asset can reasonably perform in your market. Keep assumptions conservative. Is there any opportunity to add value? What would your exit look like? etc, etc. Run a discounted cash flow analysis to determine your valuation. If you can afford to pay in this case go after it, if not move to the next deal. 

Let us know what happens! Good luck. 

Jacob