You will be able to read NAV per unit and explain why a REIT trades above or below it.
On a forum, Darren saw a post listing S-REITs trading below their net asset value, with the comment that you could buy property at a discount. One REIT on the list traded at three quarters of its NAV. It sounded like an easy decision. Darren had learned enough by now to ask why the market would leave a quarter of the value lying on the table.
This lesson explains what NAV is, how it is built and why the market so often disagrees with it.
NAV per unit, net asset value per unit, is what the REIT owns minus what it owes, divided by the number of units. In practice, most of what a REIT owns is property, and most of what it owes is debt.
With made-up figures, a REIT holds properties valued at S$4.0 billion and S$0.1 billion of other assets such as cash. It owes S$1.6 billion of borrowings and S$0.1 billion of other liabilities. Its net assets are S$2.4 billion. With 2,000 million units, NAV per unit is S$1.20.
If the units trade at S$0.90, the price to NAV is 0.75. The REIT trades at a 25% discount to its NAV. A price above NAV is a premium.
The biggest number in NAV, the property value, is not a market price. Nobody has bought the properties at that value. It comes from independent valuers, appointed to value each property, usually once a year. The annual report names the valuers and states the methods and main assumptions.
Valuers estimate what a property would sell for, mainly from the rent it earns and the return buyers expect. One common method divides the property's net income by a capitalisation rate, the yield a buyer would expect on that kind of property.
With made-up figures, a portfolio earning S$200 million a year in net property income, valued at a capitalisation rate of 5%, is worth S$4.0 billion. If the valuer decides buyers now expect 5.5%, the same income is worth about S$3.64 billion. That fall of about S$364 million comes straight off NAV. For the made-up REIT above, NAV per unit drops from S$1.20 to about S$1.02, without a single tenant leaving.
So NAV depends heavily on assumptions about rent and capitalisation rates. Those assumptions are usually updated once a year, and valuers are cautious about moving them quickly. When conditions change, such as rates rising or a sector falling out of favour, valuations tend to lag behind. The unit price adjusts every day.
A discount to NAV may be a bargain. But the market usually has a reason, and the common ones are worth checking before you conclude anything.
The market may doubt the valuations. If buyers in the market are paying higher yields than the valuers assume, the next valuation is likely to come down. The discount may be the market getting there first.
The market may be worried about debt. A REIT near its gearing limit, with lots of debt due soon, may need to raise equity at a low price or sell properties at a bad time. Either would hurt unitholders, whatever the NAV says today. Lesson 5.2, Gearing, interest coverage and the debt profile, gave you the tools to check.
The market may distrust the manager. A record of acquisitions that diluted DPU, fees that reward size, or deals with the sponsor on generous terms can all lead investors to value the units below the assets, because they do not expect the value to reach them. Lesson 4.3, How the manager is paid, and why it matters to you, covered this.
Or the sector may be out of favour, and the discount may close if sentiment changes. That does happen. It is just one possibility among several.
A premium to NAV has its own reasons: a market that expects strong growth, a sponsor with a valuable pipeline, or confidence in the manager. A REIT trading at a premium can issue new units above NAV, which can be good for existing holders.
NAV is useful as a cross-check, especially 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. Here, NAV is one row in your scorecard, with a note on the reasons for any large gap.
Darren looked into the REIT from the forum post. It had gearing close to the limit, a large loan due within a year and a recent valuation that assumed a lower capitalisation rate than recent sales in the same sector. Three reasons for the discount, before any bargain.
In the activity you will record NAV per unit and the unit price for one S-REIT and write two possible reasons for the gap, which is the habit Darren used before taking the forum's word for it.
Record NAV per unit and the unit price for one S-REIT and write two possible reasons for the gap.
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