Valuation - Nav Approach - Updated 2021

VALUATION: NET ASSET VALUE APPROACH
(Materials taken from CFA Institute : Alternative Investment)
FRANSISCA THARIA,MM
Private Market Real Estate Equity
Investments
 Since commercial real estate transactions are infrequent,
properties are valued by appraisals to find market value
to measure performance.
 Benefits :
• Current income : through leasing or renting
• Price appreciation (capital appreciation): Investors often
expect prices to rise over time.
• Inflation hedge : investors may expect both rents and
real estate price to rise during inflationary environment
• Diversification
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Characteristics of Real Estate
 Heterogeneity and fixed location: Whereas all bonds of a particular
issue and stocks of a particular type in a specific company are
identical, no two properties are the same.
 High unit value: The unit value of a real estate property is much
larger than that of a bond or stock because of its indivisibility.
 Management intensive: An investor in bonds or stocks is not
expected to be actively involved in managing the company, but a
private real estate equity investor or direct owner of real estate has
responsibility for management of the real estate, including
maintaining the properties, negotiating leases, and collecting rents
 High transaction costs
 Depreciation
 Need for Debt Capital
 Illiquidity
 Price Determination
Classifications of Real Estate
 Residential Properties include single-family houses and multi-family properties,
such as apartments. In general, residential properties are properties that
provide housing for individuals or families. Single-family properties may be
owner-occupied or rental properties, whereas multi-family properties are
rental properties even if the owner or manager occupies one of the units.
Multi-family housing is usually differentiated by location (urban or
suburban) and shape of structure (high-rise, low-rise, or garden
apartments).
 Non-residential properties include commercial properties other than
multi-family properties, farmland, and timberland. Commercial real estate is
by far the largest class of real estate for investment and is the focus of this
reading. Commercial real estate properties are typically classified by end
use. In addition to multi-family properties, commercial real estate
properties include office, industrial and warehouse, retail, and hospitality
properties. However, the same building can serve more than one end use.
For example, it can contain both office and retail space. In fact, the same
building can contain residential as well as non-residential uses of space. A
property that has a combination of end users is usually referred to as
a mixed-use development.
Private Market Real Estate Equity
Investments
 Risk Factors :
• Business conditions
• Long lead time for new development
• Cost and availability of capital
• Unexpected inflation : in a weak market with high vacancy
rates and low rents, when new construction is not feasible,
values may not increase with inflation
• Demographics
• Lack of liquidity
• Environmental
• Availability of Information
• Management
• Leverage
Real Estate Appraisals
 Valuation approaches :
• Cost approach : assume that a buyer would not pay more for a
property than it would cost to purchase land and construct a
comparable building. Value is derived by adding the land value to
the current replacement cost of a new building less adjustments
for estimated depreciation and obsolescence. Most useful when
the subject property is relatively new.
• Sales comparison approach : assume that a buyer would not
pay more for a property than others are paying for similar
properties. To make it comparable, sales price of similar
comparable properties are adjusted for differences with the
subject property. Most useful when there are a number of
properties similar to the subject that have recently sold.
• Income approach : assume that value is based on the expected
return required by buyer to invest in the subject property. Value is
equal to the present value of the property’s future cash flow.
Most useful for commercial real estate transactions.
Income Approach
 The income approach focuses on net operating income
generated from a property. There are two income
approaches, each of which considers growth. The first, the
direct capitalization method, capitalizes the current NOI
using a growth implicit capitalization rate.
 The direct capitalization method estimates the value
of an income-producing property based on the level
and quality of its net operating income.
 When the capitalization rate is applied to the forecasted
first-year NOI for the property, the implicit assumption is
that the first-year NOI is representative of what the
typical first-year NOI would be for similar properties.
Example – Direct Capitalization Method
 A property has just been let at an NOI of ￡250,000
for the first year, and the capitalization rate on
comparable properties is 5%. What is the value of the
property?
 Value = NOI/Cap rate = ￡250,000/0.05 =
￡5,000,000
Income Approach
 The second, the DCF method, applies an explicit growth rate to
construct an NOI stream from which a present value can be
derived. The DCF method discounts future projected cash flows to
arrive at a present value of the property.
 The DCF method (sometimes referred to as a yield capitalization
method) involves projecting income beyond the first year and
discounting that income at a discount rate (yield rate).
 When a DCF methodology is used to value a property, one of the
important inputs is generally the estimated sale price of the
property at the end of a typical holding period. This input is often
referred to as the estimated terminal value. Estimating the terminal
value of a property can be quite challenging in practice, especially
given that the purpose of the analysis is to estimate the value of the
property today.
Example : DCF
 Net operating income is expected to be level at $100,000 per year for the next
five years because of existing leases. Starting in Year 6, the NOI is expected to
increase to $120,000 because of lease rollovers and increase at 2% per year
thereafter. The property value is also expected to increase at 2% per year after
Year 5. The investors in the property require a 12% return and expect to hold
the property for five years. What is the current value of the property?
Income Approach
 General calculations of NOI :
• Rental income at full occupancy
• + Other income (such as parking)
• = Potential gross income (PGI)
• – Vacancy and collection loss
• = Effective gross income (EGI)
• – Operating expenses (OE)
• = Net operating income (NOI)
NOI Calculation
Real Estate Investment Trust (REITs)
 REITs is an investment vehicle for real estate that is
comparable to a mutual fund, allowing both small and
large investors to acquire ownership in real estate
ventures, own and in some cases operate commercial
properties such as apartment complexes, hospitals, office
buildings, timber land, warehouses, hotels and shopping
malls.
 At least 90% of taxable income must be returned to
shareholders in the form of dividends
 Analysts often use NAV to value REITS
What is NAV?
 2 possible measures of value :book value per share
(BVPS) and net asset value per share (NAVPS). While
BVPS is based on reported accounting values, NAVPS is
based on market value for assets.
 NAV is often used to appraise real estate or property
company. Discounts in the share price from NAV, in the
absence of positive future events indication suggest
potential overvaluation.
Net Asset Value per share : Calculation
 NAVPS is the difference between a real estate company’s
assets and its liabilities, all taken at current market values
instead of accounting book values, divided by the number of
shares outstanding.
 In valuing REIT’s, analyst will look for results of existing
appraisal if they are available.
 If they are not available or if they disagree with the
assumptions or methodology of the appraisals, analysts will
often capitalize the rental streams – represented by net
operating income (NOI)– produced by a REIT’s property
using a market required rate of return
 The market required rate of return usually referred to as
capitalization rate or “cap rate” is the rate used in the market
place in recent transaction to capitalize similar risk future
income streams into a present value.
Net Asset Value per share : Calculation
 Book value of properties will be substituted by the property

valuations obtained with price per square foot information on
transactions involving similar type of properties, as well as
replacement cost information (adjusted for depreciation and the age
and condition of the building).
 Generally, goodwill, deferred financing expenses, and deferred tax
assets will be excluded to arrive at a “hard” economic value for total
assets.
 Liabilities will be similarly adjusted to replace the face value of debt
with market values if these are significantly different and any such
“soft” liabilities as deferred tax liabilities will be removed.
 The revised net worth of the company divided by total number of
shares outstanding is the NAVPS.
Examples
Office Equity REIT Inc.
Net Asset Value Per Share Estimate
(In thousands, except per share data)
Last 12-months real estate NOI $ 270,432
Less : non-cash rents $7,667
Plus : Adjustment for full impact of acquisitions (1) $ 4,534
Pro forma cash NOI for last 12 months $ 267,299
Plus : Next 12 months growth in NOI (2) $ 4,009
Estimated next 12 months cash NOI $ 271,308
Assumed cap rate (3) 7%
Estimated value of operating real estate $ 3,875,829
Plus : Cash and equivalents $ 65,554
Plus : Land held for future development $ 34,566
Plus : Accounts receivable $ 45,667
Plus : Prepaid/Other assets (4) $ 23,456
Estimated gross asset value $ 4,045,072
Less : Total debt $ 1,010,988
Less : Other liabilities $ 119,886
Net asset value $ 2,914,198
Shares outstanding 55,689
NAVPS $ 52.33

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VALUATION: NET ASSET VALUE APPROACH

(Materials taken from CFA Institute : Alternative Investment)

 Book value of properties will be substituted by the property

Net Asset Value Per Share Estimate

(In thousands, except per share data)

Last 12-months real estate NOI $ 270,432

Less : non-cash rents $7,667

Plus : Adjustment for full impact of acquisitions (1) $ 4,534

Pro forma cash NOI for last 12 months $ 267,299

Plus : Next 12 months growth in NOI (2) $ 4,009

Estimated next 12 months cash NOI $ 271,308

Assumed cap rate (3) 7%

Estimated value of operating real estate $ 3,875,829

Plus : Cash and equivalents $ 65,554

Plus : Land held for future development $ 34,566

Plus : Accounts receivable $ 45,667

Plus : Prepaid/Other assets (4) $ 23,456

Estimated gross asset value $ 4,045,072

Less : Total debt $ 1,010,988

Less : Other liabilities $ 119,886

Net asset value $ 2,914,198

Shares outstanding 55,689

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