Apples to oranges

Because valuing real estate at cost hides economic reality, net asset value analysis is paramount

June 16, 2016

About the author

Noam Ganel, CFA is the founder of Pen&Paper, a value-oriented, contrary-minded journal of the financial markets. Between 2010 and 2020, Ganel worked for Silvergate as Vice President in Capital Markets. He provides advisory services to family offices,  private companies, and financial advisors.

If you are looking for a second opinion, especially when considering big changes to your portfolio or strategy. Unbiased, professional insights can help you reexamine your assumptions and reduce emotional decisions.

Join the waitlist to learn more.

Net Asset Value per Share (NAVPS) is often used as a benchmark for the value of a REIT. Historically, REITs have traded at premiums-to-NAVPS of more than 25 percent and at other times at discounts from NAVPS exceeding 25 percent. 

NAVPS replaces book value to determine economic reality because REITs use cost accounting models to value investment properties.

NAVPS is the difference between a real estate company’s assets and its liabilities, using market values, divided by the number of shares outstanding. To arrive at the market value of the real estate, REITs may use appraisal companies or capitalize income using the three methods to calculate capitalization rate.

Table A provides an example of the calculation involved in estimating NAVPS based on capitalizing rental streams. The capitalization rate of 5.0 percent used recent comparable transactions in the property market. Other assets of about $94 million included restricted cash, receivables, prepaid expenses, and equity investment in joint ventures. Intangible assets of $2.4 million were excluded. Total liabilities included secured and unsecured debt. The net asset value was divided by the number of outstanding shares as of February 18, 2016.    

Table A: the math behind NAVPS

Net Asset Value Considerations

Institutional investors often justify a premium to NAVPS. The rationale is twofold. First, publicly traded real estate companies offer liquidity absent in private real estate ownership. And REITs often attract above-average management, which should provide better results compared to an average privately-held investment. This results in a lower required rate of return, translating to higher real estate valuations in public markets. 

NAVPS is useful to determine capitalization rates. Analysts work backwards; doing so allows them to ascertain whether or not, based on the implied cap rates, two similar portfolios of real estate are being valued differently. 

NAVPS estimates can be quite subjective. Illiquid markets lack comparable sales to determine capitalization rates. If a REIT owns hundreds of properties, its asset value may need to be estimated using a sample of the properties. A bulk sale or a distressed sale of a portfolio may result in further discounts to value, as real estate valuation professionals Jeffrey Pelegrin, Christopher Casey and Josephy Torzewski, note in Alternative Techinques in Valuing Real Estate Portfolios

In short, NAVPS is useful as a relative tool. If a subsector of the REIT market is trading at a discount of 15 percent to NAVPS and a certain REIT operating in the subsector trades at 50 percent to NAVPS, a purchase order would be warranted.