I previously mentioned that it is a good time to buy real estate. It is important to understand how much to pay for the property.

When you are thinking about buying a home and you finally find the right property, one of the most important considerations to make is how much to actually pay for the property. Basing your valuation on the listing price is not a good idea since that is set by the seller. I think there are three main ways to value real estate:

1. Replacement Value
2. Market Value
3. Cash Flows

Valuing a property by replacement value is basically how much would it cost to replace the building and the land. I do not believe this is an accurate calculation since it only takes into account the costs of the land and the building.

Market value and cash flows should be used in tandem to get a good range of values for the property. Market value reflects what the market is willing to pay for the property. This takes prevailing market conditions into account such as the current economy and current real estate market conditions. The way to get a number using this valuation technique is to use comparable transactions. If you have a real estate agent, you can ask them to find this for you. They will go into multiple listing service (MLS), the database that real estate agents use, and will find similar/comparable properties that are close in proximity and have sold recently. The sale price of the similar property will give you a good idea of the market valuation. However, since there is rarely a property that is exactly the same, you cannot take this number at full value. This is where the cash flows come into effect.

If you want a good investment in the property, it helps to think about how much cash flow the property can generate. In other words, how much rent can you charge for the property and does that rent cover the expenses. In order to make this calculation, you would need to consider the mortgage payments, property taxes, homeowner’s insurance, and any other expenses related to owning the property. Although you may not be renting out the property, this valuation technique gives a good frame a reference and provides perspective on what it is worth.

Once you establish a price range that you are comfortable with you can submit a lower offer to begin negotiations.