Read NAV per unit and explain why a REIT's units can trade above or below it.
If you look up an S-REIT's unit price and then its NAV per unit, the two numbers rarely match, and the gap can be wide. When the price is lower than NAV, it is tempting to think you are getting property cheaply. That may be true. Before you act on it, you need to know how NAV is calculated, which part of it carries the most weight, and the usual reasons a price sits away from it.
NAV per unit (net asset value per unit) takes everything the REIT owns, subtracts everything it owes, and divides the result by the number of units. In most REITs, property makes up most of what the REIT owns and debt makes up most of what it owes.
Suppose a REIT holds properties valued at S$4.0 billion and S$0.1 billion in other assets such as cash. It has S$1.6 billion of borrowings and S$0.1 billion of other liabilities. To get net assets, add the two asset figures and subtract the two liabilities: S$4.0 billion + S$0.1 billion - S$1.6 billion - S$0.1 billion = S$2.4 billion. The REIT has 2,000 million units in issue, so NAV per unit is S$2.4 billion / 2,000 million = S$1.20.
To compare the market price with that figure, divide the unit price by NAV per unit. The result is called price to NAV. A result below 1 means the REIT trades at a discount to NAV. A result above 1 means it trades at a premium. With units at S$0.90, the example REIT's price to NAV is S$0.90 / S$1.20 = 0.75, a 25% discount to NAV.
The S$4.0 billion of property is the largest number in the calculation, and it is not a price anyone has paid. No buyer has bought these buildings for that amount. The REIT hires independent valuers to value each property, usually once a year. The annual report names the valuers and sets out their methods and main assumptions.
A valuer estimates what a property would sell for, working mainly from the rent it brings in and the return a buyer would want. A widely used method divides the property's net income by a capitalisation rate, which is the yield a buyer would expect from that type of property. For the example REIT, net property income of S$200 million a year and a capitalisation rate of 5% give S$200 million / 5% = S$4.0 billion.
The rate and the value move in opposite directions. A higher capitalisation rate produces a lower value from the same income. At 5.5%, the same S$200 million works out to about S$3.64 billion. The difference of about S$364 million comes directly off NAV, and NAV per unit falls from S$1.20 to about S$1.02. Every tenant is still there and the rent is unchanged, so the whole fall comes from the revised assumption.
This means NAV depends heavily on assumptions about rent and capitalisation rates, which are usually revised once a year. Valuers also tend to be slow to change those assumptions. If interest rates go up or investors lose interest in a sector, valuations usually take time to catch up, while the unit price moves every trading day.
A discount to NAV can be a real bargain, but the market usually has a reason for pricing units that way. Go through these reasons before you decide anything.
Doubt about the valuations. If buyers in actual sales are paying higher yields than the valuers have assumed, the next valuation will probably come in lower, and the discount may show the market pricing that in early. To check, compare the valuers' capitalisation rate with yields from recent market sales in the same sector. Worries about debt. A REIT close to its gearing limit, with a large amount of debt due soon, may have to raise equity at a low price or sell properties at a bad time. Unitholders lose out either way, whatever today's NAV says. Use the tools from Lesson 5.2, "Gearing, interest coverage and the debt profile", to compare gearing with the limit and see how much debt is due soon. Distrust of the manager. If a manager has made acquisitions that diluted DPU, earns fees that grow with the size of the REIT, or has agreed generous deals with its sponsor, investors may price the units below the assets because they do not expect that value to reach them. Lesson 4.3, "How the manager is paid, and why it matters to you", explains what to look for in a manager's record. An unpopular sector. The discount may narrow if sentiment changes. This does happen, but treat it as one possibility among several.
A premium usually reflects one of three things: the market expects strong growth, the sponsor has a valuable pipeline of properties, or investors have confidence in the manager. A REIT trading at a premium can issue new units above NAV, which can benefit existing unitholders.
Darren is a learner-investor taking this course. He came across a forum post listing S-REITs that traded below NAV, with a comment that you can buy property at a discount. One REIT on the list, referred to here as Forum REIT, was priced at three quarters of its NAV, and buying it looked like an easy decision.
By that point he knew enough to ask why the market would leave a quarter of the value on the table. When he looked into Forum REIT, he found three things. Its gearing was close to the limit, it had a large loan due within a year, and its recent valuation assumed a lower capitalisation rate than recent sales in the same sector. That gave him three reasons for the discount before he had found any sign of a bargain. He now writes down possible reasons for a gap before he takes a forum's word for it.
NAV is most useful as a cross-check, read next to gearing and DPU. It is not a valuation of the units. Building a full valuation model with discounted cash flows and multiples is taught in the course "Investing Like an Institution". In your scorecard, give NAV one row and add a note on the reasons for any large gap between price and NAV.
For the activity, choose one S-REIT and record its NAV per unit and its unit price. Then write two possible reasons for the gap between them. Darren used the same habit before taking the forum's word for it.
Write down NAV per unit and the unit price for one S-REIT, then give two possible reasons for the difference.
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