How to decide if a REIT is undervalued

How to decide if a REIT is undervalued
How to decide if a REIT is undervalued

Net asset value (NAV) and net tangible assets (NTA) are two common valuation metrics of Australian real estate investment trusts (AREITs). NTA is the balance sheet or book value of the underlying properties held within an AREIT. NAV is an analytical valuation of an AREIT based on the expected net cash flows from the property assets and profits generated from activities unrelated to income generation within the AREIT structure. These activities include operational businesses, such as funds management or property development.  

The degree that an AREIT is trading at a premium or discount to NAV and/or NTA, serves as a yardstick for assessment of the whether the AREIT is undervalued or overvalued.    

Rental income AREITs v AREITs with operational businesses  

A rental income AREIT, such as Westfield Retail Trust (WRT), derives the vast majority of its revenue from rental income. This compares with Westfield Group (WDC), which generates rental income and undertakes operational businesses such as construction, funds management, property asset management, leasing and marketing activities.  

Chart one illustrates the premium/discount to NAV and to NTA that these AREITs have traded at over three years to October 31, 2013.  

Chart one – Premium/Discount to NAV and NTA comparison

binesh_dec_4_chart_one

 

*Inception – 13 December 2010

Source: UBS, Atchison Consultants  

WDC has been trading at substantial premiums to NTA since September 2011 which is attributable to the expected profits generated from the operational businesses within the group.  

However, WDC has been trading closer to its NAV, which accounts for expected market value of the assets of the properties and profits from operational businesses.  

Pricing relative to NTA and NAV  

The premium/discount to NAV and to NTA that the sector is valued at as at 31 October 2013 is shown in Chart two

 

Chart two – AREIT Sector– Premium/Discount to NTA and NAV as at October 31, 2013

 binesh_dec_4_chart_two

Source: UBS  

Over the last 18 months, prices of AREITs have been driven upwards by investors looking for high cash dividend yield investments, within a prevailing low interest rate environment.  

As shown in chart two, as at October 31, 2013, the AREIT sector was trading at premium to NTA of around 23% and at a minimal discount to NAV of 1.5%.  

WDC, which accounts for approximately 25% of the value of the AREIT sector, skews the overall sector’s valuation. The AREIT sector, excluding WDC, was trading at a premium of around 13% and 1.7% to NTA and NAV respectively as at October 31, 2013.  

As shown in chart two, as at October 31, 2013, AREITs such as Westfield Retail Trust (WRT) Investa Office Fund (IOF), Challenger Diversified Trust (CDI) and GPT Group (GPT) have been trading at discounts to both NTA and NAV. These AREITs are undervalued by the market.

 


Binesh Seetanah is an analyst at Atchison Consultants.

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