Tuesday, November 15, 2011

Valuation Methodology Differences

Wells REIT II announced its share valuation last week at $7.47 per share.  In May, Hines REIT announced a $7.78 share valuation.  The two REITs bought similar type properties - major market, Class A office buildings -  over the same approximate time period during the mid-2000s.   It makes sense that the two values are close.  It is important to note the distinctions in the valuation methodology used by the two REITs. 

Wells REIT II was clear in its 10-Q that it valued only its real estate, and did not include a value for the REIT as a business, or its enterprise value.  Here is the wording from Wells REIT II:
Our estimated per-share value was calculated by aggregating the value of our real estate and other assets, subtracting the fair value of our liabilities, and dividing the total by the number of our common shares outstanding, all as of September 30, 2011. The potential dilutive effect of our common stock equivalents does not impact our estimated per-share value. Our estimated share value is the same as our net asset value. It does not reflect "enterprise value," which includes a premium for:

the large size of our portfolio, although it may be true that some buyers are willing to pay more for a large portfolio than they are willing to pay for each property in the portfolio separately;

our rights under our advisory agreement and our potential ability to secure the services of a management team on a long-term basis; or

the potential increase in our share value if we were to list our shares on a national securities exchange.
Our key objectives are to arrive at an estimated per-share value that is supported by methodologies and assumptions that are appropriate based on our current circumstances and calculated using processes and procedures that may be repeated in future periods. Wells REIT II believes that this approach reflects the conservative investment principles that guided the assembly of our portfolio over the past eight years, and comports with industry-standard valuation methodologies used for nontraded real estate companies.

As of September 30, 2011, our estimated per-share value was calculated as follows:

Real estate assets

Estimated net asset value per-share value

Estimated enterprise value premium
None assumed

Total estimated per-share value


Our real estate assets were appraised using valuation methods that we believe are typically used by investors for properties that are similar to ours, including capitalization of the net property operating income, 10-year discounted cash flow models, and comparison with sales of similar properties.  Primary emphasis was placed on the discounted cash flow analysis, with the other approaches used to confirm the reasonableness of the value conclusion. Using this methodology, the appraised value of our real estate assets reflects an overall decline from original purchase price, exclusive of acquisition costs, plus post-acquisition capital investments, of 8.1%.  We believe that the assumptions employed in the valuation are within the ranges used for properties that are similar to ours and held by investors with similar expectations to our investors.
The following are the key assumptions (shown on a weighted-average basis) that are used in the discounted cash flow models to estimate the value of our real estate assets:

Exit capitalization rate
Discount rate/internal rate of return ("IRR")
Annual market rent growth rate
Annual holding period
10.3 years

While we believe our assumptions are reasonable, a change in these assumptions would impact the calculation of the value of our real estate assets.  For example, assuming all other factors remain unchanged, a change in the weighted-average annual discount rate/IRR of 0.25% would yield a change in our total real estate asset value of 1.83%.

The fair value of our debt instruments was estimated using discounted cash flow models, which incorporate assumptions that we believe reflect the terms currently available on similar borrowing arrangements to borrowers with credit profiles similar to ours.

The fair value of our non-real estate assets and liabilities is estimated to materially reflect book value given their typically short-term (less than 1 year) settlement periods.

Hines REIT, which I discussed earlier this year here, uses the following language, and it does have an enterprise component:
The estimate of the per-share value was made with consideration primarily of (1) valuations of the Company’s  real estate investments, including estimates of value which were determined by the Company’s management and independent third parties using methodologies that are commonly used in the commercial real estate industry (including discounted cash flow analyses and reviews of current, historical and projected capitalization rates for properties comparable to those owned by the Company); (2) valuations of notes payable, which were determined by an independent third party; and (3) the estimated values of other assets and liabilities which were determined by management, as of March 31, 2011.  In addition, the Company engaged an independent third party to review management’s market value estimates as of March 31, 2011 for selected assets that represented a substantial portion of the Company's property portfolio, and such third party has opined that management’s market value estimates are fair and reasonable.  Finally, the Board also considered the historical and anticipated results of operations of the Company, liquidity requirements and overall financial condition, the current and anticipated distribution payments, the current and anticipated capital and debt structure, and management’s and the Advisor’s recommendations and assessment of the Company’s prospects and expected execution of the Company’s operating strategies.
Hines REIT's first three valuation points look like Wells REIT II's, but unlike Wells, none of the Hines' assumptions are disclosed.  The last sentence in the Hines REIT disclosure is where the analysis slips into the qualitative.  The board considered additional items like anticipated results of operations, anticipated capital structure, and the "Advisor's recommendations and assessment of the Company's prospects and expected execution of the Company's operating strategies."  It's naive to think the board would factor in negative projections.  It's not disclosed what percentage of Hines REIT's $7.78 per share valuation is represented by these intangible assumptions. 

I chose Hines in my comparison because I had its filing language readily available, and it's similar to Wells REIT II.  Hines REIT is not the only non-traded REIT that adds in an enterprise component when valuing its shares.  I am not against non-traded REITs having an enterprise valuation component, because non-traded REITs are companies and there is a value to that.  I just need to see how the REITs value their ongoing business, because in my opinion, it's an easy way for non-traded REITs to report a higher share value. 

I appreciate Wells REIT II's board's decision to disclose the assumptions used in determining a per share valuation.  The board should get some credit for excluding the enterprise component, which had it been included, would have resulted in a higher net asset value.

I am skeptical of any valuation for a non-traded REIT until it lists on an exchange.  That's the only valuation that's going to matter to most investors.

1 comment:

KY Investor said...

Thank You