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Leveraged Breakdowns

Real Estate Investment Trusts (REITs) for Beginners, Part Three

This third installment in our series looks at one of the key investment metrics of REITs: Net Asset Value, or NAV. For most REIT investors, the comparison of NAV to the share price is a very telling indicator of value, and the type of long term private equity real estate returns that the investment could generate.

Net Asset Value Defined

There is a simple and intuitive definition for Net Asset Value: The fair market value of the assets owned by the fund, minus the liabilities of the fund. Analysts and investors will then divide the NAV by the number of shares outstanding to arrive at the NAV per share. Comparing the NAV per share to the stock price for that REIT gives a clue as to how the market is valuing that stock relative to its underlying asset value. 

As a brief real estate investment case study, consider Blackstone’s Real Estate Income Trust. As of July 31, 2019, BREIT had an NAV of $11.20 per Class I share. This particular REIT is not traded on the public exchanges, so there is no published share price. Your own analysis of NAV, however, could be compared to the published NAV.

As another real estate investment case study, Public Storage, a publicly traded REIT (NYSE: SA) had a closing share price of $257.50 on September 6, 2019. There is no published NAV calculation, but your analysis of the assets held, locations, and cap rates would help you complete your own NAV per share calculation to determine if the stock is trading at a premium or discount to NAV.

If the stock price is higher than the NAV, the market is telling investors that for some reason, the stock is worth more than its underlying assets. On the flip side, if the stock price is lower than the NAV, the market is indicating that there are issues that make this stock worth less than the assets the REIT holds. Like many simple ratios, the analysis can’t stop at NAV per share.

What Might Be the Cause?

There are a host of reasons why the market may price a REIT stock differently than its NAV. Greenstreet Advisors, a leading CRE research outfit, has a proprietary system for determining if this difference is the result of a mis-pricing by the market or if it is a justified difference (they explain their methodology here and it is well worth the read).

As an analyst, your spidey-sense should be tingling when you think about “fair market value” as the first component of calculating NAV. You know that FMV is a function of the income stream from a property divided by the cap rate. You also know that both the income stream and the cap rate can be “managed” by those that are so inclined.

If you were to dig into a REITs assets to decide for yourself if the NAV was appropriate or not, here are some questions you might ask:

  • Are the cap rates used typical in the current market for this asset class?
  • Are the current market cap rates for this asset class over- or under-valued? Could there be a correction forthcoming?
  • Are the cap rates used appropriate for the location of the assets?
  • Is the occupancy stable across the portfolio, or are the trends telling a different story than what management is claiming?
  • Are capital expenditures being reserved for? Are there clues that could indicate deferred maintenance?
  • If there is debt on the portfolio, is it fixed or floating? If fixed, is there a risk of re-pricing soon that could impact cash flows?

REITs are an attractive investment alternative for individuals, and have become incredibly popular. They are a great source of real estate private equity returns for the masses. In your career as a REPE professional, understanding NAV will become second nature. Sharpening your skills with courses from Leveraged Breakdowns will help accelerate your learning!

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