reit valuation (final version) - sebi presentation (spring ...€¦ · dividendyield 8 1990 1992...

Valua%on of REITs

Manish Srivastava New York University

For High Level Discussion Purposes Only: Securi'es and Exchange Commission of India

Acknowledgements

In the prepara%on of these class, materials have assembled and extensively referenced (some%mes directly in their original form) from various sources from Green Street Advisors, Deutsche Bank, Barclays Capital, etc. These materials have been use to site simple disconnected examples of the various kinds of analyses for illustra%ve purposes only.

2

REIT Valua%on

•  The formula%on of the REIT regime in India is a welcome step forward that could lead to the development of a en%re ecology of real estate markets –  Valua%on issues will be at the heart of shaping this ecology

–  Let us first examine some of the broad valua%on approaches commonly associated with REITs

– We will then focus specifically on the “NAV” approach as it is quite commonly used amongst ins%tu%onal investors in the United States

3

REIT Valua%on

•  REIT Valua%on: – Two main valua%on approaches •  Rela%ve valua%on •  Absolute valua%on

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Valua%on Approaches

•  Rela%ve Valua%on – Measuring the rela%ve value of a REIT based on comparable companies

– Helps to understand differences rela%ve to peer group

– Rela%ve metrics are good for price target context and pair trades

5

Valua%on Approaches

•  Rela%ve Valua%on – Yield Comparison •  Dividend yield •  Earnings yield

– Earnings Comparison •  Trading comps •  Transac%on comps

– Net asset value (or NAV) •  a commonly used valua%on approach by ins%tu%onal investors

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Valua%on Approaches •  Yield Comparison Approach –  Dividend Yield

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Dividend Yield

8

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 20140

2

4

6

8

10

12

Source: NAREIT®, FactSet.

Exhibit 5:Equity REIT Dividend Yield vs. 10-Year Constant Maturity Treasury Yield

January 1990 - December 2014Percent

FTSE NAREIT Equity REITs Dividend Yield 10 Year Constant Maturity US Treasury Yield

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014-2

-1

0

1

2

3

4

5

6

7

8

Average Yield Spread

1990 - 2014 1.05%

Source: NAREIT®, FactSet.

Exhibit 6:Monthly Equity REIT Dividend Yield Spread

January 1990 - December 2014Percent

FTSE NAREIT All Equity REITs Less 10 Year Constant Maturity US Treasury Yield

7

Dividend Yield •  Compare yields to other REITs, in addi%on to other income

alterna%ves (i.e. 10 year Treasury Bond) •  Normally an inverse rela%onship exists between yield and

earnings growth rates •  Monitors sustainability of dividends via payout ra%os -‐ payout

ra%os of over 100% may just represent a temporary shorball due to non-‐recurring events – may not be an accurate indicator of future performance

•  Payout ra%os have declined over %me as management focus has shieed from paying as high a dividend as possible to retaining as much income as possible to fuel growth

9 Source: Barclays Capital

Valua%on Approaches •  Yield Comparison Approach –  Dividend Yield –  Earnings Yield

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Earnings Yield

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•  From GAAP Net Income to FFO to AFFO: GAAP Net Income (as per SEC Filings) + Real estate deprecia%on and amor%za%on -‐ Gain on sale of property + Loss on sale of property Fund From Opera%ons (FFO) (Reported in SEC Filings) -‐ Recurring Capital Expenditures (TI, Leasing, Cap-‐Ex) -‐  Adjustment for Straight-‐lining of rents +/-‐ Other (Gain on sale of land) Adjusted Funds from Opera%ons (AFFO or CAD or FAD)

Illustra%ve AFFO/CAD Calcula%on

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Barclays Capital | U.S. REITs

25 May 2011 56

Figure 51: SPG CAD Calculation

Cash Available for Distribution Calculation SPG (1)$ in millions except psf amounts

Start with FFOFunds from Operations $2,361.8

less: Maintenance capexMaintenance capex psf $0.58Estimated portfolio square footage 158,895,813

Maintenance Capex $92.6

less: T.I. and L.C. expendituresTenant improvements and leasing commissions psf $26.66Assumed leasing activity (sq. ft.) 3,942,045

Total T.I. and L.C. expenditures $105.1

less: Non-cash income and gains/lossesStraight-line rents (net of deferred financing costs) $63.6Non-cash extraordinary one-time items $0.0

Non-cash income and gains/losses $63.6

Cash Available for Distribution $2,100.5

1) Based on Barclays Capital 2011 estimates as of 5/20/11

Source: Barclays Capital, company documents

Our favorite multiple is the forward CAD multiple, which represents how many dollars investors are willing to pay per dollar of a given REIT’s next year of expected cash flow. While the multiple elides more complex factors such as longer-term growth, leverage, and operational risk, higher growth names tend to have higher multiples and riskier names tend to have lower multiples. In this way, we believe that a forward CAD multiple gives a reasonable back-of-the-envelope approximation of the relationships we seek to capture in our discounted cash flow analysis.

We believe that our CAD estimates better reflect the economic reality of owning and operating real estate portfolios—and more importantly the cash flow available to equity holders—than does FFO. That said, the methodology for calculating FFO is standardized by NAREIT and followed consistently across different REITs, while CAD is a metric we calculate internally.

Ideally, we would look at a historical series of forward P/CAD multiples in order to gauge current or implied valuation relative to a REIT’s own historical valuation levels and those of its peers. However, there are several complications—the short history of publicly traded REITs, a lack of standardized historical CAD data, changes over time to REIT portfolios, and uncertainty as to which forward estimates were embedded in a stock price during a given period—that render this exercise less fruitful than it might seem in theory. Different analysts may end up with different values for CAD (also known as AFFO or FAD), presenting a challenge with respect to sorting out historical valuations. Data providers tend to favor CAD numbers published by the companies themselves, even though methodologies between those companies vary; moreover, the number of companies for which these CAD numbers

On a spot basis, we favor forward P/CAD multiples.

Why CAD?

On a historical basis, we (reluctantly) favor trailing P/FFO

multiples.

•  AFFO/CAD yield: •  Calculate year 1 yield and 5-‐year CAGR

•  Add to arrive at yield (~IRR) •  Rank companies based on IRR •  Higher yield implies undervalued company

Earnings Yield


Earnings Yield

14

-50

-40

-30

-20

-10

0

10

20

30

40

50

1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012

FTSE NAREIT All Equity REITs Annual Returns

1972 - 2014

Price

Income

Returns (%)

Average Annual Total Returns: 13.84%

Average Annual Income Returns (reinvested): 7.90%

Source: FTSETM, NAREIT®.

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•  Strength •  Captures future implied growth based on es%mates •  Expects yield differences will revert to the long-‐term mean

•  Weakness •  Can mistakenly iden%fy companies with major problems as

amrac%ve investments •  Yields differences can con%nue to move away from the long-‐term

mean and stay there for much longer than expected •  Shie from REITs as income vehicles to total return vehicles makes

the yield approach less useful

Yield Comparison Approach


Valua%on Approaches •  Earnings Mul%ple Approach –  Trading Mul%ples

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Trading Mul%ples

•  Iden%fy companies within comparable: –  Geography –  Sub sector (property type) –  Size of Gross RE Assets

•  U%lizes informa%on embedded in current share price •  Apply consistent methodology to calculate FFO and AFFO (historic or forward?)

•  Provides useful rela%ve informa%on on the sub-‐sector and on rela%ve valua%on

•  Why would companies trade at different mul%ples?


Trading Mul%ples


Trading Mul%ples •  Rela%ve Value Metrics: Earnings Mul%ples – Price to Funds from Opera%ons (FFO): Approximates Price/EPS (P/E ra%os) •  Pros: Quick easy method for valuing companies on a rela%ve value basis •  Cons: Due to non-‐cash items included in FFO, FFO mul%ples and over or understate rela%ve valua%on


Trading Mul%ples •  Rela%ve Value Metrics: Earnings Mul%ples – Price to Cash Available for Distribu%on (CAD): Approximates FCF (Free Cash Flow) •  Pros: Gets at the recurring cash profile of a company •  Con: Cap-‐Ex can be lumpy due to leasing and can skew es%mates


Valua%on Approaches •  Earnings Mul%ple Approach –  Trading Mul%ples –  Transac%on Mul%ples

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Transac%on Mul%ples


Valua%on Approaches •  Net Asset Value (NAV)

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Net Asset Value •  Involves valuing the company and its stock, not just proper%es and must therefore consider:

•  Underlying quality of assets (real estate porbolio) •  Market fundamentals

•  Company management teams •  Strengths / weaknesses

•  Balance sheet •  Flexibility / liquidity •  Debt maturity schedule

•  Growth prospects •  Development pipeline


Net Asset Value •  NAV is essen%ally a proxy for book value or balance sheet equity

•  Values the real estate por%on of the balance sheet based on the cash flows that this real estate generates and current expected market return on those real estate cash flows (capitaliza%on rates (“cap rate”), inverse of a mul%ple)


Net Asset Value •  By using NAV, one can value a company’s real estate based on the property yield demanded of similar real estate in private transac%on markets and then put that value in the context of the REIT’s capital structure

•  This allows for property level comparability between REITs – which most metrics that are dependent on corporate-‐level cash flows do not provide


Net Asset Value •  Also, allows us to value non-‐opera%ng assets, such as land, cash, and securi%es, which may not otherwise be captured in the cash flow model

•  Price/NAV works as a useful measure of rela%ve value within a sector at a given point of %me

•  Offers a reasonable ballpark measure of a REITs equity – based on expected property-‐level cash flows for the next year and the REIT’s exis%ng capital structure


Net Asset Value •  Measuring property yields at the asset level, NAV ensures that REIT cash flows are driven by property yield, rather than by management over-‐leveraging low property yields to drive high returns to equity – as many private market real estate players did in 2006 and 2007)


Net Asset Value •  With an NAV analysis, one can place different mul%ples on different income streams – for example, we would use a different cap rate for an asset management fee stream than we would for an opera%ng property


Example of NAV Calcula%on

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25 May 2011 61

Figure 55: Example of a REIT NAV Calculation – AVB ($ in thousands) AvalonBay Communities Net Asset Value (1)$000 Current Value

Assumed Assumed NOINominal Economic before Int. Exp. % of Gross

Capitalized Income Cap Rate Cap Rate (2) after CapEx $ per share AssetsNOI Contribution from (3):Apartment Properties 5.14% 4.84% 576,762 11,915,538 $136.45 86%Pro Rata JV Properties 5.14% 4.65% 12,816 275,528 $3.16 2%Third Party Mng't 12.0% 4,516 37,633 $0.43 0%

Real Estate Operations 12,228,699 $140.04 89%

% of CarryingBalance Sheet Assets Value (4) B/S ValueDevelopment and LandConstruction in Progress 110% 330,243 363,267 $4.16 3%Land Held For Future Development 105% 193,593 203,273 $2.33 1%

Total Development and Land 523,836 566,540 $6.49 4%

Gross Real Estate Value 12,795,239 $146.53 93%

Other Balance Sheet AssetsCash and Cash Equivalents 476,932 476,932 $5.46 3%Other Assets 401,406 401,406 $4.60 3%Investments in Uncons. JVs 0% 0 0 $0.00 0%Benefit of Tax-Exempt Debt (5) 128,198 $1.47 1%

Other Balance Sheet Assets 1,006,536 $11.53 7%

Gross Market Value of Assets 13,801,775 $158.05 100%

Balance Sheet LiabilitiesDebtMortgage Debt 2,217,397 $25.39 16%Line of Credit and Term Loan 0 $0.00 0%Unsec Debt (ex Line of Credit) 1,819,786 $20.84 13%Pro Rata JV Debt 219,893 $2.52 2%

Total Debt 4,257,076 $48.75 31%Other Liabilities 417,065 $4.78 3%

Total Liabilities 4,674,141 $53.53 34%

Other Claims on EquityPreferred 0 $0.00 0%Minority Interest, excl. OP units 6,691 $0.08 0%

Other Claims on Equity 6,691 $0.08 0%

Net Asset ValueNet Market Value of Assets 9,120,943 $104.45 66%

Diluted Shares & Units Outstanding 87,323Current Value per share $104.45

Valuation MeasuresPrice Per Share AVB $126.61Price/Current Value 121.2%Enterprise Value/Gross Market Value of Assets (6) 114.0%

Implied Cap Rates Nominal EconomicNumerator Total less CapEx

Forward 12-month NOI 626,435 589,578DenominatorEnterprise Value 15,736,792 15,736,792Non-NOI-Producing Assets 1,610,709 1,610,709

EV for Operating Real Estate 14,126,083 14,126,083

Implied Cap Rate 4.4% 4.2%NOI Yield to Total Debt 14.7% 13.8%

Price per UnitEV for Operating Real Estate 14,126,083Operating Units 52,029

Price per Unit $271,505

(1) AVB's current value is based on 1Q11 balance sheet, and 1Q11 NOI annualized.(2) Economic cap rate is used, as NOI includes a deduction for recurring capital expenditures.

(3) Deducts $36.9 million in recurring capital expenditures from AVB's next 12 months estimated NOI.(4) Unless otherwise specif ied, am ount is 100% of carrying value.

(5) We multiply the tax-exempt debt outstanding ($726.5 MM) by a 150 basis point subsidy and capitalize at 8.5%.(6) Total enterprise value = m arket value of common equity plus total liabilities. Source: Barclays Capital

Source: Barclays Capital

Example of NAV Calcula%on

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25 May 2011 61





























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Net Asset Value •  This approach to NAV is then further be refined as follows:

NET ASSET VALUE

+

WARRNATED PREMIUM TO NAV

=

WARRANTED SHARE PRICE (Can be used to compare valua%ons rela%ve to other REITs)

33 Source: Green Street Advisors

Warranted Premium to NAV •  The Warranted Premium to NAV is a func%on of: –  Franchise Value –  Balance Sheet Acumen –  Balance Sheet Risk –  Capitalized value of Unusual G&A –  Corporate Governance


Warranted Premium to NAV •  Franchise Value: –  Franchise Value reflects management’s propensity to add or decrease value through capital alloca%on and balance sheet management

– Management Value Add is a metric that measures management’s contribu%on to franchise value beyond that generated by property apprecia%on

–  By stripping out NAV growth from proper%es, MVA gives more credit to managers in tough markets and less credit to managers in the right locales


Warranted Premium to NAV •  Balance Sheet Acumen: –  Balance Sheet Acumen gives credit for the diversity of financing sources and cheap cost of debt -‐ access to a variety of financing op%ons is desirable

–  Unsecured debt has gained a cost advantage in recent years – companies get credit for having access to this market and more credit is given for higher ra%ngs

–  Preferred stock financing market access gets credit – although there have been instances where preferred stock investors have taken a hit in the absence of properly wrimen contracts that protect their rights in a change of control situa%on


Warranted Premium to NAV •  Balance Sheet Risk: –  Balance Sheet Risk – focuses on capital structure – low leverage is good!

–  Combines: •  Leverage Ra%o (Mark-‐to-‐market Liabili%es + Preferred)/Current Value Assets, and

•  Debt to Opera%ng Assets (Book Value Debt / EBITDA/Cap Rate) –  Other considera%ons:

•  Near term maturi%es •  Non-‐recourse debt •  Unfunded development •  Property sector leverage ra%os


Warranted Premium to NAV •  Capitalized Value of Unusual G&A: –  Capitalized value of Unusual G&A is quan%fiable –  The warranted premium to UAV emana%ng from G&A equals the variance between a company’s G&A and the sector average

–  This is then divided by the All-‐REIT cap rate


Warranted Premium to NAV •  Corporate Governance: –  Corporate Governance entails a whole set of parameters related to governance issues such as board, an%-‐takeover weapons, poten%al conflicts of interest

–  Let us look at the way Green Street factors in corporate governance in its valua%on models


Corporate Governance

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Category Maxm. Points Ideal Structure

Board Ra'ngs: Non-‐staggered Board 20 Yes Independent Board 5 80% + Investment by Board Members 5 Large Investment by Numerous Members Conduct 25 No Blemish, Fair Comp, Leadership

Total 55

An'-‐Takeover Weapons:

State An%-‐takeover Provisions 12 Opt out/Shareholders Approve Change

Ownersip Limits from 5/50 Rule 5 Limit Waived for Ownership by other REITs Shareholder Rights Plan 10 Shareholders Must Approve Implementa%on Insider Blocking Power 8 No Veto Power

Total 35

Poten'al Conflicts of Interest: Business Dealings with Management 6 No Business Dealings Divergent Tax Basis of Insiders 4 Basis Near Share Price

Total 10

Perfect Score 100 Source: Green Street Advisors


41



Total 55




Total 35


Total 10



42



Total 55




Total 35


Total 10


An'-‐takeover Weapons: There are only a handful of REITs where insiders hold a blocking posi%on, but it is a big deal where

it exists . . .


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Total 55




Total 35


Total 10


. . . Because of that, a cap is placed on how many points a REIT

where blocking power present can score on an%-‐takeover rankings.

Aeer all, the an%-‐takeover provision don’t mamer much if insiders

control the vote


44



Total 55




Total 35


Total 10


Implica%ons of NAV •  NAV analysis brings to light a very interes%ng aspect of the US real estate market which may also be applicable to the Indian market as it evolves –  Real estate is perhaps the only asset class that can claim to have both well developed private and public markets (at least in the US)

–  A REIT can exploit this unique feature to its great advantage and create permanent value in perpetuity


Implica%ons of NAV – When the REIT’s shares trade at a premium to NAV, the management can raise equity in the public markets and use it to buy assets in the private markets while maintaining the fixed leverage ra%o

– When the REIT’s shares trade at a discount to NAV, the management can sell assets in the private market and use the capital generated to buy back its shares in the public market while maintaining the fixed leverage ra%o

–  This process can be adopted in up and down markets crea%ng a unique opportunity of public/private arbitrage – this is in fact the lowest hanging fruit for a REIT


Valua%on Approaches

•  Absolute Valua%on

47

Valua%on Approaches

•  Absolute Valua%on – Useful for intrinsic valua%on •  Highly subjec%ve •  Cash flow driven •  Margin of safety

– Generally used to drive price targets


Valua%on Approaches •  Absolute Value Metrics – Measure REIT stock prices in rela%on to actual assets held by those REITs •  Price/SF/Unit •  Replacement Cost •  Implied Cap Rate •  Discounted Cash Flow


Absolute Valua%on Approaches •  Implied cap rates – Represents the cap rate that would result in an NAV equal to REIT’s stock price

– Divide the forward 12-‐month NOI es%mate by REIT’s adjusted enterprise value (equity market cap + debt – non-‐real-‐estate assets)

– Compare to es%mates of the market cap of the REIT’s porbolio


Valua%on Methods: Implied Cap Rates

•  The implied cap rates of a REIT’s gross real estate assets is derived from the market value of its equity: Cap Rate = NOI / Value of Gross RE Assets

Equity Value = Value of Gross RE Assets + B/S Value of (Non RE Assets – Value of Liabili%es – Preferred – NCI*)

Or stated another way: Value of Gross RE Assets = Equity Value -‐ B/S Value of (Non RE Assets – Value of Liabili%es – Preferred – NCI*)

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*NCI = Non Controlling Interest



•  We already know that: Cap Rate = NOI / Value of Gross RE Assets Therefore: Implied Cap Rate = NOI** / (Equity Value – Non RE Assets + Liabili%es + Preferred + NCI*)

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*NCI = Non Controlling Interest ** Either TTM or One Year Forward NOI can be used in the calcula%on



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25 May 2011 61





























Discounted Cash Flow •  Discounted Cash Flow (DCF) Analysis – Best indicator of intrinsic value – Combines detailed growth assump%ons with risk discoun%ng

–  Incorporate long term view of what a REIT can earn going forward


REIT Valua%on •  Thank you!

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reit valuation (final version) - sebi presentation (spring ...€¦ · dividendyield 8 1990 1992...

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