Real Estate Appraisal Theory
The value of the bundle of rights, called Real Estate, is not well understood. The misunderstanding of the dynamics underlying the ascertainment of property value is one of the contributing factors to the nation-wide collapse of Real Estate prices after the 1987 Tax Reform Act and is the subject of much confusion for Local Property Tax Authorities and property owners.
To derive a value for the bundle of rights, we might assume that the value of the bundle relates to the Sum of its Parts, but there are problems with method. An alternative way of valuing property would be to select the Highest and Best Use of the property, but this is also problematic. Because of these problems, I developed what I call the Market Weighted Asset Model, which overcomes the inherent problems in conventional appraisal theory.
Weighted Asset Model
In the Weighted Asset Model I define the value of the bundle of rights, called Real Estate as the present value of expected future returns to be derived from ownership of the property. Because, a given property may have many possible uses, and therefore a wide variety of potential values. The Market Weighted Asset Model weights each potential value by the likelihood of its occurrence to derived an overall value for the bundle of rights.
However, Real Estate is seldom sold for cash, and for good reason, because for each intended use of the property there is an optimal leverage position depending upon the purchasers degree of risk aversion. Generally, this optimal leverage position occurs around the point at which the return on cash flow becomes positive. When the cash flow returns become positive, then the corresponding inflation-adjusted-after-tax return is optimized. To derive this optimal leverage position, I include a program called Reinvest (an easy to use general purpose real estate calculator). This optimal leverage position has a feed-back effect, in turn, increasing or decreasing the value of the asset.
Maximize Leverage
When purchasing property the investor has two primary concerns.
- How much cash do I spend
- and what do I get in return.
The clearer way of understanding real estate is measure asset value in terms of the return on invested capital. Then the investment can be understood relative to other investments, like stocks and bonds.
Carl Marx did not have the benefit of the �return on capital theory� for valuing assets and many current appraisal methodology's are based upon socialists methodology's that do not function well in a capitalist economy.
The solution is the answer to the following question: How much cash do I put-down in order to reduce the amount borrowed, and correspondingly reduce the payments to generate a positive cashflow, yet at the same time get as much leverage as possible in order to magnify the rate of return. Then, if these returns are adjusted for inflation and Federal Income Taxes, the returns represent some sort of 'Pure Money'.