What do you mean? Isn’t that what banks do?
In numerous conversations with bankers over the past month, I have heard the following refrain at least a half dozen times: “We are unable to extend you credit based on real estate collateral because we just don’t have a handle on what it’s worth.” We will ignore the fact that these are finance professionals for now, but I assure you I will come back to it later. My immediate response is what’s new? Apparently banks were never able to value real estate otherwise they would never have made half the loans that are eating them alive right now. But I guess it didn’t matter when they could package them up as commodities and sell them to investors with an A grade credit rating.
Given that so banking professionals are at a loss at how to value real estate I thought I would be an upstanding member of the business community and share my secret formula for investment valuation and real estate success. I use a concept known as the present value of future cash flows. I project revenues, assume a certain expense ratio, inflation and income growth rates and discount it by my weighted average cost of capital. This gives me a rough sense of what the property is theoretically worth. I then look at other factors to fine tune my valuation estimate. I know many recognize this formula and must be thinking the same thing as me when I hear a professional banker say “We just don’t know what it’s worth right now” Aren’t you a finance professional and who is we? Are there a bunch of finance professionals at your organization who don’t know how to discount future free cash flows? I am not sure if banks really don’t know how to value real estate, or are just using that as an excuse to not lend me money. I suspect it’s the latter, or at least I hope it is.