COMMERCIAL
Earnings don’t make property companies tick. Long-term income is more important.’
asset values, as investors expected their property portfolios to be revalued and the asset value to increase. That can be a warning sign. By the middle of 2005, property companies were trading at an average five per cent premium to their net asset value, perhaps the first sign that valuations were getting overstretched. A number of smarter investors and fund managers had exited the commercial property sector entirely before it hit the skids in 2007. But a premium to net asset value might
also reflect the likely development gains for a property developer such as Helical Bar, which trades at a 28 per cent premium to NAV. This prices in the likely revaluation of its developments once they are completed. Helical Bar has often generated above average returns by buying sites without planning permissions – and gaining permissions for change of use, so in this case the premium reflects the nature of the company rather than an assessment of the market as a whole. That might seem fairly simple. What’s
tricky is working out which asset value to use, as with earnings, there’s a choice. EPRA net assets is calculated on the basis that the portfolio is eternal, so to speak, so it doesn’t include any deferred taxation. On the other hand many analysts prefer to use ‘triple-net’ (also referred to as NNNAV), which adjusts for deferred tax and for the fair value of the company’s debt, so it’s a
so property should yield more than bonds, to compensate for that extra risk. One of the things that made smart
investors wary of the property sector from 2005 onwards was the fact that the spread (the difference between yield on property and that on bonds) had fallen to only one percentage point. In other words, investors who were dazzled by the property sector’s fast growth had pushed prices up to a point where property no longer offered real value as an income play. Now, things are different. Despite a
recovery in property valuations from the credit crunch lows, the yield gap is still quite large. Nick Parker, Senior Analyst with CB Richard Ellis, says, “The yield gap between property and government bonds hasn’t narrowed by as much as during previous cycles, with an approximate 400 basis point positive yield gap at present. This underlines the fact that the current risk premium remains elevated due to ongoing concerns over growth prospects and worries about income
security in many occupier markets.” The yield gap is one thing City analysts
look at to assess the direction the sector as a whole might take. However, yield is less important when comparing one property company against another. It only allows the investor to assess the return from the shares, not the underlying portfolio. So more often, it’s net asset value per
share that analysts use to compare property companies, that is, the value of the property portfolio, less borrowings and other liabilities, divided by the number of shares in issue. Generally, property companies trade at a discount to net asset value, which has varied over time from more than 40 per cent, to a slight premium. The discount will tend to vary in
accordance with investors’ expectations of the market and its future direction. The City is always trying to look forwards, so if investors think property values are likely to increase, the discount will tighten or even disappear. Earlier this year, many property companies traded at a premium to their
‘The yield gap between property and government bonds hasn’t
narrowed by as much as during previous cycles.’ NICK PARKER sENIoR ANAlyst, CB RIChARd EllIs
better proxy for the break-up value of the portfolio. This can lead to confusion when using services such as Digitallook which provide information on consensus estimates and company financials, as they don’t specify which convention is being used, or whether analysts worked out their own pro forma NAV. Of course once analysts have assessed
the metrics for a company, they will also look at qualitative factors, the vacancy rate, the quality of tenants and covenants, and the quality of the portfolio. Sometimes the type of property can be important, last year, companies with a high exposure to
PROPERTYdrum FEBRUARY 2011 59
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