By George L. Yungmann
When investors talk, publicly traded companies listen. A number of real estate companies have responded to investor and analyst interest by disclosing their calculation of net asset value (NAV) on a per-common-share basis. Investors and analysts look to a real estate company's per-share NAV and the relationship of this value with the market value of the company's common stock as a way to determine whether the shares are trading at a premium or discount to the value of net assets underlying "shareholders' equity."
In addition, investors and analysts can evaluate a company's historic NAV growth and the past relationship of NAV per share with the company's common stock price. The results of this analysis can also be used for peer group and sector comparisons.
However, as the article "An Inexact Science" in this issue points out, estimating NAV may be done in more than one way. Described below are current practices in calculating and reporting NAV and suggestions for appropriate disclosures.
Although much of the data an investor or analyst requires to calculate NAV is available in a company's financial statements or notes, many companies are facilitating the process by presenting their own calculations and by showing the components and assumptions used within quarterly supplemental operating and financial reports. Some of the companies that have disclosed their NAV components and/or calculations include: Acadia Realty Trust (NYSE: AKR), Apartment Investment & Management Co. (NYSE: AIV), Archstone-Smith (NYSE: ASN), First Industrial Realty Trust, Inc. (NYSE: FR), Home Properties of New York, Inc. (NYSE: HME), ProLogis (NYSE: PLD), Sun Communities, Inc. (NYSE: SUI) and United Dominion Realty Trust (NYSE: UDR).
There are several figures common in a typical NAV calculation. The components generally include: net operating income (NOI) generated by the consolidated property portfolio; cash flows from properties owned in unconsolidated subsidiaries; management or other fee income; values for other assets; liabilities; preferred stock (if any); and the number of diluted common shares and operating partnership units outstanding at the valuation date. In some cases, property NOI and cash flows are categorized by property type and/or location.
The NOI used as a basis for valuing properties generally represents a 12-month-forward estimate, adjusted for portfolio occupancy normalization, as well as straight-line rents, if applicable. Additional adjustments may reflect normalized capital expenditures, dispositions, acquisitions and developments added to the operating portfolio, or other changes in NOI from the existing portfolio. Management or other fee income generally represents cash flow from short-term contracts.
Other assets would include development projects, land held for future development or sale, other investments in unconsolidated subsidiaries, cash and cash equivalents, and miscellaneous items. The value of properties under development typically reflects the historical cost-carrying amount adjusted to reflect potential increases or decreases in value depending on the outlook for the projects' success. The value may be estimated based on projected net cash flows and current investor yield requirements for the related assets. Land that is held for development or sale may be similarly valued. Any remaining assets, as well as liabilities and preferred stock, are usually included in NAV at historical cost net book value.
The number of common shares and operating partnership units would be measured on a diluted basis at the date of valuation, reflecting any convertible securities that would dilute earnings per common share if converted.
As shown in the accompanying table, the first step in calculating NAV is to estimate a value for the consolidated property portfolio by applying a capitalization rate to NOI. A similar calculation is made for the cash flows generated by properties owned in unconsolidated subsidiaries. The capitalization rate, which is derived from recent market transactions and represents current investor yield requirements, is adjusted to reflect the characteristics of a company's portfolio. Relevant characteristics include property type, class, age, and location, as well as the quality of in-place leases/tenants. In some cases, a capitalization rate may be developed based on characteristics of individual or groups of properties. To take into account capital expenditures, companies may either adjust NOI or the capitalization rate.
Sample NAV Components and Calculation
($ in thousands)
NOI – Forward 12-month estimate $345,678 Adjustment for straight-line rents (if applicable) (12,345) NOI from property portfolio* $ 333,333 Divide by NOI capitalization rate 8.5% Value of property portfolio $3,921,565 Management or other fee income $9,876 Divide by appropriate capitalization rate 20.0% Value of management or fee income $49,380 Add other assets:
$654,321 Land held for future development or sale $123,456 Other investments in unconsolidated subsidiaries $56,789 Cash and equivalents $45,456 Other miscellaneous assets $54,321 Gross value of assets $4,905,288 Deduct:
$1,889,899 Preferred stock $150,000 Net Asset Value $2,865,389 Divided by total diluted common shares/operating partnership units 123,456 Net Asset Value per share $23.21 Sensitivity analysis:
Net Asset Value per share based on NOI capitalization rate 50 basis points higher than calculated above
$ 21.45 Net Asset Value per share based on NOI capitalization rate 50 basis points lower than calculated above $ 25.20 * Operating properties, including properties owned in unconsolidated subsidiaries
The next step in calculating NAV would be to estimate a value for the management or fee income by applying a capitalization rate to projected cash flows.
The values for all other assets are added to the estimated value of the property portfolio and management or fee income to calculate the gross value of the company's assets. Then total liabilities and preferred stock are deducted to arrive at the net value of the company's assets. Finally, total diluted common shares/operating partnership units are divided by the NAV to determine NAV per share.
Cautions and Conclusions
Some observers have cautioned against relying on NAV because the estimate is based on a degree of subjectivity. Others suggest that NAV is a necessary analytical tool because a real estate company's net assets measured by depreciated historical cost is irrelevant to an analysis of the relationship between the company's underlying net assets and its common share price.
To enhance the reliability of property valuations, actual operating results generated in periods immediately preceding the valuation date are generally used to calculate 12-month-forward NOI estimates. To compensate for the subjectivity of capitalization rate selection, a company could provide a sensitivity analysis of the NAV calculation. For example, the analysis could calculate per-share NAV using a range of capitalization rates that would provide a per-share NAV range based on reducing or increasing capitalization rates by 25 or 50 basis points.
Another consideration in the analysis of NAV is that the calculation usually looks at only one point in time and therefore may exclude important company transactions. This can be addressed by making adjustments for the potential impact on NAV from recent or pending acquisitions, dispositions, and debt or equity financing transactions. By applying qualitative judgment to quantitative analysis, NAV can be one of many tools available from an investor's or analyst's toolbox used to evaluate the investment quality of a real estate company's common shares.
George L. Yungmann is vice president, financial standards for NAREIT.