Before one can understand how distressed assets are valuated, one must have a basic understanding of what distressed assets are. Once we have a basic understanding of distressed assets, we can better comprehend the process of valuating distressed assets.
Distressed Assets 101
Distressed assets are those assets that have a severely depressed value due to reasons that are particular to the issuer, and not due to such things as the general market conditions. In the majority of cases, distressed assets become as such due to the issuer’s default on principal or interest of the asset.
In many cases, distressed assets are also victim of low occupancy rates, state of disrepair and inability to refinance existing debt. There are investors who focus on acquisition of distressed assets. Such investors must be extremely knowledgeable in the area of distressed assets, valuation of distressed assets, and must have the capitol for investment in the distressed asset in order to acquire, rehabilitate and for the repositioning of distressed assets in order to make a profit.
Valuation of Distressed Assets
Some investors invest in distressed assets because it seems like an opportunity for quick cash-flow. However, investing in distressed assets has its own set of dynamics and risks involved. Especially due to the dynamics and risks of distressed assets, one should undertake such investments with great caution. While distressed assets are supposed to be valuated based on fair market value at the time, there are factors that can hinder valuating distressed assets. One of the issues can be a lack of information.
The information gap among banks and potential investors can allow for price inefficiencies. In the case of larger companies, they are often forced to sell out at less than fair market value and with poor timing as a contributing factor. In the case of valuation-driven distressed investments, there is typically no transformable event in the near future, such as an event that will increase assets.
Equity analysis is important when considering how distressed assets are to be valuated. Distressed assets do not have the cash flow or the borrowing capabilities as do more profitable assets. An investor in distressed assets needs to be willing to hold onto the distressed asset to profit from what the investor may determine is a foreseen future event that will net a profit once the particular event materializes.
Although investing in distressed assets during times of recession and immediately following a financial crisis may seem attractive to some, with the potential available for possible deep discount deals on distressed assets and then turning them into substantial profit, there is still substantial risk.
The lack of confidence where distressed assets is concerned makes for a not so friendly environment for distressed asset investors. Yet with the vast number of distressed assets available not only in the U.S., but in global and emerging markets, if one knows the procedures for valuating distressed assets, is willing to hold onto the distressed asset for a future foreseen event, or is willing to work with asset liquidators, then the distressed asset investments environment may prove profitable for many investors.