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Real Estate & REITs
Re: Analysts

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By Vinocur
January 13, 2004

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In the calculation of NAV, the person performing the estimate (and NAVs are estimates) has to determine a capitalization rate to apply to the properties' NOI.

When looking at industrial REITs, most analysts typically employ a cap rate in the 9% range. In the case of a portfolio such as AMB's or PLD's, which are generally viewed as being of higher quality, analysts may use an 8.5%, versus another's portfolio that gets a 9.0% or 9.5%. However, as I noted in my last post, high quality industrial assets are changing hands at cap rates in the 6%-7% range today. That's way below even the most aggressive cap rates being used by analysts.

It would be incorrect to state that all that there is to an NAV estimate is the cap rate -- however, it is a major determinant. There are other issues such as the marking to market of above market rate debt, which some analysts (notably Green Street) do that others don't.

However, the heart of the NAVs are too high debate centers on the choice of cap rates. Sam Zell, for instance, recently said he thought analysts' cap rates were 20% too high. In the data I cited, buy-siders -- based on our proprietary data -- seem to believe today's premium is on the order of 8% to 10%. (Again, NAV is a levered number.) Whereas some analysts are at 18% or even 24% (some a bit higher). Our own consensus estimates, which include all estimates (not just the buy-side) are higher than buy-side estimates.

Now, lest I leave you with the impression that analysts are daft and that they are just using the incorrect cap rate, the analysts recognize that private market cap rates are lower than the ones they use for their NAV estimates. They argue, however, that the low cap rates reflect the lower interest rate environment. In their view, cap rates will rise as interest rates rise. They are reluctant to revalue their NAVs for a long-term asset based on what they view as cyclical change in cap rates. Some argue (mostly REIT execs) that the changes reflect the fact that investor return expectations have changed (in part, at least) and that therefore the changes are secular.

My own view, as I noted, is that the secular thesis is an interesting one, but that there's insufficient datapoints at present to draw a hard-and-fast conclusion. That said, I believe that NAV should reflect today's market -- cyclically impacted or not. After all, if NAV is a break-up analysis (at least in part) then investors are interested in what those properties could fetch today -- not in the long-run. At the very least, I think analysts who steadfastdly cling to the cyclical argument should acknowledge that their NAVs reflect numbers that are lower than what would be fetched by the properties today.

This isn't a one dimensional argument, however. For instance, some believe that even if their NAVs are cyclically high, that as NOI rebounds (which it eventually will for those sectors challenged today) that companies will "grow" into their NAVs. Now, I should point out that some argue that buy-siders have a vested interest in maintaining that valuations aren't way out of whack. After all, if a money manager believes the market is paying way more than today's value, one might argue they have a fiduciary obligation to tell investors that. Since if investors thought prices were way out of whack in their favor they might yank their money out of those investments -- the cynics argue money managers' views may be colored by their own pecuniary interests.

Now, NAV is but one number. It's one to be mindful of IMO, but it's by no means the only valuation metric to look at. So, when I express my view that valuations are stretched, it's looking not just at NAVs, but also at other metrics, such as multiple-to-growth ratios, AFFO yields, etc.

Is real estate worth more on Main Street than on Wall Street? In some instances, that's the case. And, yes, there are companies that have used the fact that real estate markets are awash in liquidity to sell some assets and reposition their portfolios. Others have done jvs, as EOP announced the other day.

JVs are a whole other subject. Ever so briefly, most cos see JVs as a way to leverage their returns. They generally view the assets they place in JVs as slower growing (institutions are generally more focused on steady income than growth, so slower growth isn't a major issue for them). The REITs retain an interest (typically 20% to 25%, but it varies) -- which gives them a piece of the upside -- and they structure the deals so that they get fees for management etc. They also include a promote, which provides further upside should the assets appreicate significantly.

Barry Vinocur


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