(NA)Valuations for all seasons

Alex Moss

Alex is Director of the Real Estate Research Centre at Cass Business School as well as being Course Director for their online MSc course in Global Finance, and a Visiting Professor at Henley Business School. He currently chairs the EPRA Research Committee and is the founder of Consilia Capital, which provides strategic advice on global real estate capital markets.

It is well known that the UK listed sector (in aggregate) currently trades at a significant discount to underlying net asset value (NAV). This masks sharp divergences between sectors and management teams but is true of the two ‘bellwether’ stocks – Landsec and British Land – used by generalist investors to gain exposure to the sector. The key questions to be asked are: Which NAV calculation is used? Is NAV the only/optimal valuation measure for UK REITs throughout the cycle?
The purpose of this first article is to look at the recently announced changes to the Best Practices Recommendations (BPR) for NAV calculation by EPRA, which will be implemented for accounting periods starting January 1, 2020. The second article, next quarter, will look at alternative (non-NAV) valuation measures, which are used globally to determine if they have relevance to the UK and who would be the winners/losers from these methodologies.
The background
The UK uses IFRS accounting standards, which include mark-to-market valuations of assets. It also has a highly-regarded valuation system, a long (30-year+) data series of valuations of assets in the direct market, a highly regarded valuation profession and a ‘Red Book’, which contains the rules and best practice guidelines for undertaking these valuations to ensure consistent application across the profession. What then, could possibly go wrong? In short, two things:
1- Share prices do not have a consistent relationship with the valuation of the underlying assets (see Chart 1). They range broadly from a 10% premium to a 45% discount.
2- Not everyone calculates their NAV in a similar manner.
The best way to answer the first point is not to take a forward-looking share price and compare it to a historic property valuation. This can be easily resolved by professional investors who have access to brokers’ forecasts and can compare the current share price to the forecast NAV in one or two years’ time, or indeed the expected trough.
The best way to assess the second point is to adopt a common standard by companies for reporting NAV. Sixteen years ago, EPRA introduced its Best Practices Recommendations guidelines for calculating NAV. Investors know that comparing a Landsec EPRA NAV to a British Land EPRA NAV will be comparing apples with apples.
However, there have been several issues arising; despite best intentions, for a variety of reasons the NAV did not reflect either the value of the business or the price at which the assets could be sold. A current example would be secondary/tertiary shopping centres/retail parks, where aggregate demand is limited, and assets are put on the market to reduce leverage, i.e. aim to be sold in a relatively short timescale.
The new EPRA NAVs
As a result, following extensive discussions with investors, accountants and the companies themselves, EPRA has now replaced their NAV and NNNAV measures with three new specific NAV measures:

  • Net Replacement Value (NRV) – aims to represent the value required to rebuild the entity and assumes that no selling of assets takes place.

  • Net Tangible Assets (NTA) – is focused on reflecting a company’s tangible assets (i.e. excluding goodwill etc.) and assumes that entities buy and sell assets, thereby crystallising certain levels of unavoidable deferred tax liability.

  • Net Disposal Value (NDV) – assumes an orderly sale of the business netting off the deferred tax, financial instruments and any other liabilities.

All three start from the same point: IFRS equity attributable to shareholders and companies will be expected to show they transition from EPRA NAV/NNNAV to these new three metrics.
The disclosure of all three is compulsory so that none of the three new metrics would lose prominence (as happened with the EPRA NAV and EPRA NNNAV).
Why change?
In our view, there are several reasons why a single NAV figure (be it EPRA NAV or EPRA NNNAV) is no longer deemed enough, most of which relates to corporate strategy and the divergent growth rates of the underlying assets.
The listed sector used to be relatively simple; most companies operated a broadly buy/develop and hold strategy. Because of sharply divergent growth rates amongst the underlying assets, the varying levels of operational risk/management expertise required and gearing levels, there is now a sharp valuation divide between those companies forced to sell assets to reduce debt in the short term and those companies building a scalable presence in a preferred sector of the market.
Who may benefit?
A lot of attention will be given to which of these three metrics a company thinks is most applicable to its corporate strategy.
Let us take a couple of examples. For companies that are building a platform and have a clear competitive edge in terms of critical mass, they might argue that NRV is the appropriate measure. Examples would be companies who have traded or are currently at a premium to EPRA NAV because of superior growth prospects and the fact that they represent critical mass and provide investors with a liquid way of participating in a specialist sector. An obvious example in this category would be Tritax Big Box, which has built up a 31 million ft2 larger-scale logistics portfolio currently valued at just GBP 4 billion with a weighted average unexpired lease term of >14 years and a significant development pipeline. This is a highly focused and desired portfolio that would be impossible to replicate.
Similarly, the Unite Group has built up a UK student accommodation portfolio of 51,200 operational beds with a total value of GBP 5.5 billion, of which Unite’s share is GBP 3 billion, again with a secured development pipeline for further growth.
It may be the case that when one looks at the true value required to rebuild these entities. For example, the NRV figure is higher than a traditional NAV and, therefore, the share price rating appears less demanding than if a standard NAV was applied.
Similarly, there has been a lot of market speculation regarding public to private transactions, and the acquisitions of Intu and Capital & Counties in particular. The NAV figure that private buyers (be they PE Funds or Sovereign Wealth Funds) would start with for their calculations would be NDV, which assumes an orderly sale of the business netting off the deferred tax, financial instruments and any other liabilities. This would provide the platform to underwrite a transaction and determine the level at which an offer should be pitched, which may be lower than a standard NAV.
In summary, therefore, we believe that the introduction of these new EPRA NAV calculations is an enormous step forward as it will allow investors to determine and differentiate between:

  • The value of the operational business

  • The value of the tangible assets in the business

  • The break-up value of the business.

As such, there should, therefore, be greater granularity around market pricing, with the appropriate NAV being applied to the appropriate corporate strategy.