When Intrinsic Value Trumps Market Value
By Katharine Briggs, Chief Operating Officer, B2R Finance
Real estate investors can find today’s housing market frustrating when appraised values on their rental portfolios come in lower than what they believe the properties are truly worth.
Market value —the price that a house would sell for in a reasonable period of time — may vary widely from the intrinsic value — which can be thought of as the value of the property’s cash flow to a patient owner. Under a cash-flow scenario, the intrinsic value of a rental property might be much higher than the market value.
Market value is influenced by conditions in the real world, such as housing bubbles and recessions. Intrinsic value is what property would be worth in a perfect world, in a market at equilibrium.
Market imbalances can provide great opportunities for home investors. But these same imbalances result in time periods where the market value and intrinsic value are not equal.
It can be very frustrating for an investor when a professional appraiser determines a property’s market value is less than the owner thinks the property is worth. While an appraisal is one person’s opinion, it is based on a trained expert’s assessment of the home’s condition and other variables such as the selling price of other comparable homes in the same neighborhood.
Borrowers may first learn of lower-than-expected market values for their single-family rental portfolios when they approach a lender such as B2R Finance to borrow against their rental portfolio.
Our investors are sometimes disappointed because they feel the property is worth more due to strong rental cash flow. And for patient and savvy investors, they are right. However, we lend against market value. B2R Finance, like most other lenders, is compliant with the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, commonly referred to by its acronym FIRREA. FIRREA is a set of lending guidelines established in the wake of the nation’s savings and loan crisis in the 1980s to address unregulated companies performing incompetent or fraudulent appraisals. And B2R’s independent appraisers follow the widely accepted Uniform Standards of Professional Appraisal Practice (USPAP) in arriving at market value.
B2R’s mission is to be a trusted partner to residential real estate investors. Our goal is to lend money to our customers so that they can continue to invest in their properties and grow their portfolios. So even if the market value falls short of what the borrower had hoped for, investors should consider other factors when deciding whether to seek a real estate loan:
1. Mortgage interest rates are at historic lows and it is still a really affordable time to buy.
2. B2R Finance will advance up to 75% of the market value of a real estate portfolio and give the investor credit for the lease cash flows. Both often result in higher loan proceeds as compared to a commercial bank.
3. Opportunistic real estate windows may close. The disconnect between intrinsic value and market value will narrow. An improving economy could mean investors will face increased competition for homes from owner-occupants if purchase originations rise as expected next year. Now may be a good time even if the loan amount desired isn’t as high as was hoped for.
4. While a lender might be lending less money than was desired, investors can still take that money today and do something with it rather than waiting for the market value to reach the intrinsic value. There are opportunity costs associated with waiting.
Some investors have played it smart, taking advantage of the imbalance between market price and intrinsic value to add to their portfolios while prices are still affordable and interest rates are low. Now may be a good time to continue to invest while enjoying the yield that comes from a still unrecognized intrinsic value on one’s existing single-family rental portfolio.
The information on this page is provided for informational purposes only and does not constitute investment, real estate, or legal advice. This information should not be regarded as a recommendation or an offer to buy or sell any product or service to which this information may relate. No representations or warranties whatsoever, express or implied, are given as to the accuracy or applicability of the information contained herein. The information may be modified or rendered incorrect by changes in the marketplace or developments in the law, or for any other reason, and may not be applicable to any individual reader’s facts and circumstances.