Inherent Value

I was watching the CNBC rerun of the special "The Millionaire Inside" and while I loved and hated a lot of what was said, one principle stuck out at me as a very good rule of thumb. I believe it was Phil Towne talking about his way (and Warren Buffet's way) of picking stocks.

He said, "Find out what the company is worth and then wait for it to go on sale." Simple, right? That's the beauty in this principle.

Here's how it applies to real estate: Find out how much it would cost to build a similar home in the Sacramento neighborhood you're looking at. You can easily get this information from a contractor or an insurance company in terms of a dollar per square foot amount. Then, find out the value of the plot. Adding them will give you the inherent value (or underlying value) of the house. Then, wait for it go on sale. Which means, if the price the home is being offered for on the MLS is under what it would cost to build it, you buy it. If not, you don't.

If it sounds that simple, it is! But your math has to be accurate and there is no substitute for due diligence.

Another thing, as with stocks, the general rule of thumb is, if there is any negative publicity in regards to accounting, you walk away from it, no matter how attractive the deal looks. With real estate, that could translate into the local economy, job prospects in the area, socio-economic change and so on. Remember: you can make projections only with stability. Any sudden changes (in this respect) are bad for investing.

You have to be able to trust the groundwork to make future projections.