What is Investment Value?
Investment value is the amount of money an investor would pay for a property. It refers to an asset’s specific value based on certain parameters. It is an individual’s measurement of the asset’s property value.
Potential investors often adopt an investment value metric when they decide to invest in property (real estate) with certain personal investment goals in mind. It can include a certain return on investment rate that they are looking for in an investment. The value metric is motivated by the beliefs of a certain investment strategy.
Importance of Investment Value
The reason an investment value is important to potential buyers of a property is that they want to compare the price of the real estate to the anticipated rate of return. When they find the specific rate of return, they can measure the investment’s final results with the projected price they will pay for the property. It allows the investor to make intelligent purchasing decisions that are in line with their investment objectives.
How to Determine Investment Value
Since investment value depends on the investor’s objectives, the value is unique to each investor. Different investors can use the same valuation methods and come up with different investment values. Investors can choose among several valuation methods when determining the investment value of an asset. Below are the most commonly used investment measures:
1. Comparable Sales
The sales comparison approach is used by appraisers as well. An investor will compare similar properties on a per square foot or per unit basis.
2. Gross Rent Multiplier
The metric measures an investment’s value by multiplying the gross rent a property produces in a year by the gross rent multiplier (GRM). The GRM figure is derived from similar properties in the same market.
3. Cash on Cash Return
The cash on cash return figure is calculated dividing the first year’s pro forma cash by the total initial investment.
4. Direct Capitalization
Direct capitalization is another metric used by appraisers. It involves capitalizing the income stream of a property and is a common method used to determine the market and investment value of commercial property.
5. Discounted Cash Flow (DCF)
The DCF model is used to calculate the net present value, the internal rate of return and the capital accumulation comparison. The ratios listed above, while providing useful information, also come with several limitations. Such constraints are solved by calculating the discounted cash flow.
Investment Value vs. Market Value
While investment value measures the potential value of an investment based on certain conditions, market value measures the true value of an investment based on the forces of supply and demand in the free market. Market value is determined by using an appraisal process. It is different from investment value, which takes into consideration a person’s unique goals, objectives, and needs for the property.
The investment value can be lower or higher than the market value. It depends on the property’s specific situation at the time. The investment value can be greater than the market value if a buyer places a higher value on the property than an informed purchaser.
In the real world, such a situation can exist if a company expands its premises to a larger building that’s been put on sale right across its current office. The company is willing to agree to a price higher than the building’s market value to ensure that competitors stay out of the area.
In such a case, the extra investment value is derived from the strategic advantage the company will gain by buying the property. A single investor can also agree to an investment value that is higher than the market value. It occurs if the investor receives a special tax status or highly beneficial financing terms.
Alternatively, the investment value can also be below the market value. It can happen when the investment is not the type of property that an investor would normally concentrate their efforts on. For example, a multi-family developer that is considering the idea of developing a hotel can cause the investment value to be lower than the market value.
It can be a result of the high costs involved in learning how to develop the property or because investors are demanding a higher than average return from the property due to their portfolio’s allocation and diversification.
CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful: