Three ways

According to valuation theory, there are only three ways to value anything: cost, market, and income.

As it applies to real estate, the Cost is the replacement cost new less deprectiation plus the land value. This is typically used on brand new buildings, old buildings whose structure has little value, and special purpose properties.

The market approach is the process of comparing similar sales to the subject property and making adjustments to the sale price to determine the subject's estimated sale price.

The income approach is the present worth of the rent that could be collected from a particular property. It can be calculated via discounted cash flow or by capitalization (like the inverse of a P/E ratio).

As this applies to stock investing, there was a good section in Bruce Greenwald's book using adjusted book value of Intel to determine when it is over/under valued. I think this is the best example of using the "cost" approach to value a company.

Using the sales comparison approach is common among investors. In J. Dennis Jean-Jacques's book, he recommended keeping a "sales" database by watching mergers and acquisitions in the paper.

The income approach is familiar to anyone who has heard of P/E ratios or DCF's. But I will add that going through a formal DCF for a commercial property and estimating when certain capital improvements will be made is very illuminating.

Originally Posted 6/13/05