“I can’t sell this couple on anyone. If their financial history was made into a movie, it would be in the “Horror” section. Well, the “Drama” section would fit, too. And with eight kids, it could probably be get into the “Adult Content” section as well… (Charlotte Realtor bemoaning the plight of their rent-to-own client with less than stellar credentials)
“Beauty is in the eye of the beholder.” (Plato paraphrased)
In the world of corporate mergers & acquisitions (M&A), the name of the game is negotiation. If you are a big company, you want to acquire a competitor for as little as possible. On the other hand, if you’re the smaller fish (or “acquiree”) you want to sell yourself for as much as possible. So the companies go back and forth and try to pitch their case for their “true value” as fervently as possible.
But how does one find “true value?” Well, the common method is to take book value (what you can sell all your assets for) and add in the future value of projected cash flows. From this, you get what the company is worth. This sounds so simple.
If it was so simple, the majority of young males right out of college wouldn’t lie to women at bars and tell them they were “investment bankers.” Investment bankers are the people who value the companies and put these deals together. By doing so, they make a lot of money and work a ton of hours. This accomplishes two things for these young suitors:
1. Women think they are probably rich and, thus, would be a good future mate
2. Women think they have a legitimate excuse for seldom calling and shouldn’t be offended if they only hear from them at late hours of the night after “work” functions
But, I digress…
The reason these investment bankers make so much money is not when they calculate the book value of a company; this is easy. In normal deals, anyone can appraise the assets and give a market value. And, on most deals, this yields the least amount of money. The trick (and there most of the worth is locked) is in the estimated value of future cash flows. What are they really worth?
An example: A drug company has cash flows of $100M a year and is growing at a 10% clip. This should be easy to value, right? But what if the company has a drug in their pipeline that (they say) is two years away from being patented and serves a $2B market. What is that worth? Shouldn’t that be used in the value calculation? Probably, right? That’s the main reason why the big pharmaceutical company wants to buy them. But there is no guarantee the drug will ever be approved. Hmmm…
This is where it gets tricky. And this is where the investment bankers earn their money. What do they do?
They create the narrative. They tell a story (that fits their goal) and use chosen statistics to back it up. This isn’t lying; no one knows what is going to happen in the future.
Four years ago, Wachovia Bank bought Golden West Financial for $25.5B on the investment banker narrative that it would give them a formidable bank presence on the West Coast and access to the lucrative California market. The investment bankers that Golden West hired said this deal would increase their future cash flows for years! As you know, it didn’t work out like that. A few years later, Wachovia almost went bankrupt as a result of this deal and was gobbled up by Wells Fargo.
It works the other way as well. When Google was a start-up and looking for capital, they made many promises of how they would provide great, future returns for their investors; all they needed were a few millions dollars. They swore they would revolutionize the internet. And Google’s investment bankers were right- their investors made obscene returns on their money and most don’t ever have to work again. It turned out that the value of the company’s future cash flows in the narratives told was extremely understated.
So, how does this tie into rent-to-own tenants? Most of the time, on paper, there “book value” is very low. They have lower credit scores, might have a foreclosure on their record, and might have even had to be evicted. Who wants to work with this person? Based on their record, you probably don’t even want this person renting your home. They’ll never buy and might not even pay rent! If you don’t want them, how will you sell someone else on their merits? Before you shut the door, remember that book value is a small part of valuation.
The question is: What is their future value? What is the narrative behind the tenant’s story? We run into good people all the time that have had some difficulties in their life. Divorce ripped apart their financial situation; neither spouse was willing to pay a bill (crushing their credit) and they both hoarded and hid their cash. Or job loss happened and they couldn’t get rehired. Or their son got sick and they didn’t have the proper insurance coverage; they leveraged everything they had to save him. Wouldn’t you do the same thing?
When you have a questionable candidate, be like an investment banker. Find out what the story is. Many times, this is where the “true value” is found and how you can sell the probability of good future cash flow for the seller. Once you find these selling points, you can create a narrative which creates value for you, your client, and the seller (win-win-win). 700+ credit stories are easy to sell (great book value); the harder cases are where you earn your money through the narrative (while increasing your client base and earnings).
Remember, maximizing value is all about the narrative!
Brett Furniss is the President & Owner of BDF Realty (“Charlotte’s Most Innovative Property Management & Investment Company”), and Rent-To-Sell Realty (“When You Need a New Solution to Sell Your Home”) which specialize in rent-to-own (lease options) and rent-to-sell homes. You can contact him directly at Brett@BDFRealty.com.
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