Non-Traded Financial Assets – Illiquid, Non-Traditional, Alternative Investments

What is a unique, illiquid, non-traditional financial asset?
Income producing investments are financial assets. Examples: shopping centers, apartment houses, rental retail properties, vacant real-estate, closely held businesses, mineral interests, and life insurance policies; loans, real estate mortgages loans, and promissory notes are in this classification. These income producing financial assets will be our focus. They are all important investing categories and they all require individual valuation appraisals.

Why are these non-traditional assets difficult to value?
The valuation problem they present is their unique characteristics make finding comparable investments difficult. They are not traded on a financial market; therefore, they do not have readily determined buy-sell prices. The current value of stocks and bonds, the more traditional investment assets, are readily ascertained because their buy-sell prices are published hourly and daily-it is all public information. In contrast, loans, mortgages and promissory notes do not trade publicly. Every transaction is private. The parties to the transaction wish to keep their business activities private. This lack of pricing information causes great difficulty in valuing unique financial investments. The valuation difficulty also affects their resale value; it impacts their marketability and liquidity.

Real Estate Mortgage Loans and Promissory Notes as Financial Investments
Loans and mortgage notes are held in many investing accounts. This type of investment includes real estate mortgages, promissory notes secured by deeds of trust or liens, and unsecured loans.

The investor, or a hired professional, is responsible for collecting payments, securing and inspecting collateral, and, if the note is secured by real property, ensuring the timely payment of property taxes, and verifying insurance coverage is current and adequate. If nonpayment occurs, the investor is responsible for foreclosure or debt collection processes.

The valuation question to be answered by the investor and the appraiser is, “are the invested funds adequately protected from loss”? Factors to be considered are:

• Does the real estate securing the loan provide adequate value to cover the principal and interest of the loan in the event of a default?
• Does the borrower have the financial capability to repay the loan?
• Do the loan documents establish the priority of mortgage lien as a first position lien?
• Is the hazard insurance adequate to protect the property?
• Is the loss-payee clause in the insurance policy accurate?
• Are proper records being kept of all income and expense items?

Appraising, valuing and managing real estate promissory notes
Appraising and managing real estate promissory notes presents numerous challenges. Environmental liability, leases, rent collection, property tax payments, insurance coverage, physical inspection of the property, maintenance, repairs, and capital improvements are factors requiring attention.

While most loans and notes have a higher yield than traditional income assets, they generally have longer maturities and less liquidity then stocks or bonds. They are not readily marketable, they may require large capital outlays compared to other investments, and they require inspection of the collateral. All of these factors add to the difficulty of arriving at market values.