Given the current interest (dare I say hysteria) associated with investing in dirt and buildings, I thought it might be interesting for our readers to have a quick, dirty manual on real estate valuation. My perspective comes from years in the industry as well as some time learning at the knee of some of the better real estate minds in academia.

I will separate (to some degree) investing in one's residence, for consumption, from investing in real estate for fun and profit. The reason for this separation is that much of the utility or value of one's home is locked in the pleasure one gets from living in it, or consuming it. Although there are certain ego strokes to owning large buildings, an edifice complex - if you will, the value associated with land, apartments, office buildings and warehouses is locked in the cash flow they provide or will provide. [That edifice complex comes in to play with large, trophy assets - I wouldn't expect any of our readers to be buying the TransAmerica Pyramid or the Sears Tower, but there is an interesting argument as to why those buildings deserve premiums over their nearby competitors - that discussion will have to take place at another time.]

The first basic principle to understand is that any asset is only valuable to the degree to which it will provide cash flow to its owner. It is important to see office buildings, not as office buildings, but as rent creation machines. One should see land, not as dirt, but as an option to build and rent out or sell - and thus, create cash flow.