In real estate, the most important number is not what an asset is worth. It is what you paid for it. That number is your basis, and it follows you for the entire life of the deal.
Your basis is your all-in cost in a property: the purchase price plus the capital you put in to improve it. Investors often express it per unit of the asset so they can compare across deals: per square foot, per acre, or in IOS, per land square foot.
Here is why basis is the number I keep coming back to.
Your basis sets your downside. Buy at a low basis and you have a margin of safety built in before you underwrite a single dollar of income. You can charge below-market rent and still make your return. You can survive a soft year. You can outlast the buyer who paid too much, because your breakeven is lower than theirs.
Buy at a high basis and the opposite is true. Everything has to go right just to get back to even. The market does not care that you overpaid. It only knows what it will pay you next.
Basis is also why we obsess over replacement cost. If my basis is at or below what it would cost to build the asset new, a developer cannot construct a competing property and undercut me on rent. They would lose money doing it. My basis becomes a moat.
One clarification, because people mix these up: there is also tax basis, which is what you use to calculate depreciation and your eventual gain. Related concept, different purpose. When I talk about underwriting a deal, I mean your investment basis. What you are truly in it for.
Like diamonds, basis is forever. The price you pay is the one decision you never get to make twice.
What is the lowest basis deal you have ever done, and did it protect you the way you hoped?
Wednesday Real Estate 101: Basis
