REIT Valuation: Net Asset Value Approach
Value is a relative term.
In accounting, a lot of assets are held at historical cost. It's an option with IFRS for investment properties and an established practice with US GAAP. So as property values change, how would you rate book values as a tool for estimating market value?
Not really, no.
Absolutely.
Book values are rather useless for estimating what properties are worth. That's why __net asset value (NAV)__ is estimated using other methods, and then depending on how many shares there are, a REIT or REOC can be valued using __net asset value per share (NAVPS)__.
Suppose you have a REIT with 100,000 shares. If you can look at appraisal reports and trust their values, then great. Just add those up, include the cash, accounts receivable, and other assets, then subtract liabilities, and divide. Maybe the appraisals add up to a total of USD 12,000,000, and then adding other assets and subtracting liabilities takes you to a NAV of USD 11,000,000. Then you have
$$\displaystyle \mbox {NAVPS} = \frac{11{,}000{,}000}{100{,}000} = 110 $$.
What would you do if you don't trust the appraisals for some reason?
No. You can do better than that.
Yes.
And you have a couple choices here. You can estimate a value per square foot or square meter, as these are commonly estimated for various properties and regions. Then apply that to the REIT's properties. Or you can use the net operating income (NOI) and the cap rate estimated for the properties to determine value as before.
Probably not. If an appraisal is off, it could be off either way. Just decreasing this estimate of NAVPS could make a bad estimate worse.
Suppose you have NOI for the past 12 months of USD 861,000. Good start. You'll want to adjust for any accounting tricks like straight-line rent estimates, which typically means to remove noncash rents. That leaves you with a pro-forma NOI for the past 12 months of USD 850,000. Do you want to use this value or next year's value?
No. Recall that valuation is always done on next year's NOI, just as any sort of DCF model would use. No different with NOI and the cap rate.
Of course.
Maybe you have an average or estimated growth rate of 2% on these properties as far as rents go. That's fine. Just add 2% to the adjusted NOI from last year, and you have USD 867,000. If you assume a cap rate of 7%, then your estimated value is 12,385,714.
$$\displaystyle V = \frac{850{,}000(1.02)}{0.07} = \frac{867{,}000}{0.07} = 12{,}385{,}714 $$
Maybe those appraisals weren't so bad after all. Or maybe you're both off in some direction (the appraisals could have relied on this same method).
From there, just make the same adjustments for NAV (subtract 1,000,000 again) and divide by the same 100,000 shares for your estimated NAVPS of USD 113.86. So it's a bit higher, but the question remains about what this REIT is worth. Is USD 113.86 per share the "right REIT" price?
You can't be sure. The thing is, all you have now is a private market value. A private real estate investor would see these properties worth this much. But the management of the REIT can add or subtract value. The existence of the REIT here offers liquidity to investors, and the management team is presumably good at doing their job and making decisions about activities. If so, what market price would you expect?
No. These are positive things that would justify a premium price.
That's right.
This has been observed. Over time, REITs and REOCs have been known to trade at up to a 25% premium over NAVPS. That's some serious value added.
But it goes both ways. They can also trade at up to a 25% discount as well, when management is poor or other conditions make investors feel that these properties in this setup just aren't worth their private values.
Because value is, and will always be, a relative term.
To summarize:
[[summary]]
Bad
Good
Guess
Use another valuation method
Decrease the NAVPS by some uncertainty estimate
This value
Next year's value
A discount to NAVPS
A premium to NAVPS
Continue
Continue
Continue
Continue
Continue
Continue
