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Real Estate Calculating Replacement Costs

Discussion in 'Real Estate Investing' started by JScott, Nov 25, 2007.

  1. JScott
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    JScott Legendary Contributor FASTLANE INSIDER Speedway Pass LEGENDARY CONTRIBUTOR

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    SteveO made the following comment in another thread:

    "Purchase well below replacement cost. As vacancies tighten up and rents climb, monitor for a time to sell. Once the builders start going at it again, your older propety should be close to the top of the market. Sell as it approaches replacement cost in value."

    This advice is consistent with what Volluci says, and Volluci says that to calculate replacement costs, you can essentially follow one (or both) of two paths:

    - Consult local building associations
    - Consult the Marshall & Swift residential cost handbook

    Which leads me to two sets of questions... :)

    1. For those who have done this, can you elaborate on how you calculate replacement costs on buildings?

    - Does Marshall & Swift still publish the "gold standard" of building costs?

    - Are Marshall & Swift costs location-dependent? (I imagine the costs in Seattle are different than the costs in Nebraska)

    - Are there other recommended ways of calculating replacement costs?


    2. How do you calculate the replacement cost of an old building in disrepair? Do you use the cost of a brand new building with new materials and new building styles? Or do you augment that cost to take into account the fact that you are replacing something that has much wear and tear?

    For example, say I find a building being sold for $1M. It would cost $500K to repair the building to the point of making it tenant-ready, and it would cost $1M to repair the building to the point of being "like new."

    When I calculate the replacement cost, I find the cost (to replace with a brand new building of similar size, layout and units) to be $2.5M.

    So, do I compare the $2.5M replacement cost to the $1M cost of the building? Or to the $1.5M cost of getting the building to tenant-ready? Or to the $2M cost of getting to the building to "like new?"

    Obviously, depending on how I evaluate it, the building might appear to be *much* below replacement costs (if it was the $1M I was looking at) or just a little below replacement costs (if it was the $2.5M I was looking at).

    As always, thanks for any info!
     
  2. EasyMoney_in_NC
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    EasyMoney_in_NC Contributor

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    If you are "in" well enough with your property insurance provider, they typically do a "replacement" cost calc to decide what your premium should be. I find them a little high, but I am biased being a builder, but if you have to hire a GC to replace something, then it really may be a somewhat accurate calculation. I would bounce the details of the building off of that person to see what they come up with. If nothing else, it gives you something to bounce other #'s off of. And it will be locally more accurate that a generic published calculation.
     
  3. andviv
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    andviv Gold Contributor Read Millionaire Fastlane FASTLANE INSIDER Speedway Pass Summit Attendee

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    Easy's advice sounds very good. I was about to propose that you call the appraiser and see what figure they come up with or what numbers they use.
     
  4. SteveO
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    SteveO Legendary Contributor FASTLANE INSIDER Speedway Pass LEGENDARY CONTRIBUTOR Summit Attendee

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    I find insurance numbers to be very realistic and easy to obtain. The land value component is going to vary within each area. For simplicity, just come up with an average.

    I don't think you need to get too hung up here as long as you have a good ballpark estimate. Say for example that the replacement cost is 90K/unit. Your purchase price should be well below this number. It will probably be around 40-60K.

    The main indicator that will tell you the value is approaching replacement cost will be a rash of construction permits for apartments. There are other variables that may determine whether you even get close to replacement cost or maybe even go beyond. Barriers to entry are key elements here. If it is easy to find and develop land and loans are easy to obtain, you may not reach replacement cost.

    Don't confuse the cost of new construction for "A" class properties with existing "C" buildings.

    Everything is an estimate. Keep your eyes on the indicators. :tiphat:
     
  5. SteveO
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    SteveO Legendary Contributor FASTLANE INSIDER Speedway Pass LEGENDARY CONTRIBUTOR Summit Attendee

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    If you are doing your management correctly, you will not have a building in disrepair.

    The buyer is going to want a discount for any deferred maintenance.

    You can't compare apples to oranges or "A" class to "C".

    You are making this much more complicated than it needs to be.

    If I purchase a property for 1M and it needs 500K to get it in order, I will change my mind and let you buy it! :smx8:

    Just kidding.

    That seems like a lot of fixup though. Perhaps a better example would be a 1M property that need a new roof, some appliances and a few carpets. Say this all comes to around 200K. You should be getting a discount for these repairs and hopefully have it built into the loan. You care that the property is in good condition. It does not need to be in new condition.

    You would estimate the cost to rebuild this same product and add the land value to it to come up with the replacement cost. If this comes out to 2.2M then you would have about 1M difference.
     

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