RPAI's recent initial public offering and listing brought into harsh relief one problem with non-traded REITs estimating per share valuations - these valuation approximations may vary significantly from the REITs' stock market values. In June 2011, RPAI (then known as Inland Western REIT) presented shareholders with an estimated per share value of $6.95. Investors were rightly shocked when in early April 2012, a short eight months later, RPAI had its IPO and listing at a price equivalent of $3.20 per share. RPAI has settled in around a split-adjusted equivalent price of $3.60 per share (which is $9.00 per share on NASDAQ due to RPAI's reverse stock split), and while better than its IPO price, the current price is no salve to investors. The stock market is valuing RPAI around half of what RPAI management estimated its share value less than one year ago, and this with the backdrop of a retail real estate market that is gaining strength.
It's important to understand the distinction between what REIT management estimates a REIT's shares are worth and the price at which the public markets value a REIT's shares. Obviously, in the case of RPAI there was a big difference. Listed stocks, whether REITs or high flying tech companies, rarely trade at prices that equal to their net asset value. Stocks trade above or below their estimated net worth all the time. The whole Benjamin Graham school of value investing is based on the notion of investing in stocks that can be purchased for less than companies' intrinsic values. Generally, stocks, REITs included, trade based on the outlook for expected future earnings, not necessarily the value of the underlying assets.
After a REIT completes its offering period, its sponsor must provide shareholders periodic estimates of the REIT's value. I will discuss this in more detail in my next post, but non-traded REIT sponsors use multiple factors to determine a REIT's share price, including net asset value estimates and comparisons to other public REITs. REIT management compiles the data and presents the estimate to the REIT's board for approval. In a June 20, 2011, 8-K filing, RPAI's management provided an estimated per share value of RPAI's shares and disclosed in generalities the methods it used in determining the $6.95 per share value:
On June 14, 2011, the board of directors (the “Board”) of Inland Western Retail Real Estate Trust, Inc. (the “Company”) established an estimated per-share value of the Company’s common stock of $6.95. This estimated per-share value is being provided solely to assist broker dealers in connection with their obligations under applicable Financial Industry Regulatory Authority (“FINRA”) rules with respect to customer account statements and to assist fiduciaries in discharging their obligations under ERISA reporting requirements. The estimated value was determined by the use of a combination of different indicators and an internal assessment of value utilizing internal financial information under a common means of valuation under the direct capitalization method. No independent appraisals were obtained. Specifically, the estimate of the estimated per-share value was made with primary consideration of the valuation of the Company’s real estate assets which was determined by the Company’s management using methodologies consistent with publicly traded real estate investment trusts in establishing net asset values, and the estimated values of other assets and liabilities determined by the Company’s management as of March 31, 2011.The estimated per-share value is only an estimate and may not reflect the actual value of our shares or the price that a third party may be willing to pay to acquire our shares. The Board, in part, relied upon third party sources in arriving at this estimated value, which reflects, among other things, the continuing impact of adverse trends in the economy, the real estate industry and the current public equity markets. Because this is only an estimate, we may subsequently revise any estimated valuation that is provided. We cannot provide assurance that:
- this estimate of value reflects the price or prices at which our common stock would or could trade if it were listed on a national stock exchange or included for quotation on a national market system; or
- this estimate of value could actually be realized by us or by our shareholders upon liquidation; or
- shareholders could realize this estimate of value if they were to attempt to sell their shares of common stock now or in the future; or
- the methodology utilized to estimate the per-share value, would be found by any regulatory authority to comply with requirements of such regulatory authority, including requirements under ERISA, FINRA rules, other regulatory requirements or applicable law.
Further, the estimated per-share value was calculated as of a moment in time, and, although the value of the Company’s shares will fluctuate over time as a result of, among other things, developments related to individual assets and changes in the real estate and capital markets, the Company does not undertake to update the estimated value per share on a regular basis.
The first paragraph is the key to RPAI's valuation. RPAI was valued by its management without the use of third party appraisers, or even a third party valuation service, to confirm RPAI's management's assumptions and methodologies. RPAI's management used the direct capitalization method and "methodologies consistent with publicly traded real estate investment trusts." No detail is provided on what cap rates were used, or what comparable public company valuation metrics were employed - i.e. FFO multiples. I'd be curious to know what assumptions RPAI's management made regarding all RPAI's debt, especially the debt maturing over the next several years. The valuation is only as good as the inputs and assumptions, and while the methods may have been sound, the inputs dictate the output.
RPAI's management may have convinced itself and the board that RPAI's net asset value was $6.95 per share, but RPAI's stock is currently valued around $3.60 per share share. The $6.95 price per share may be technically correct based on RPAI's valuation assumptions, but the real, tangible value for investors is, unfortunately, $3.60 per share. Going forward, the net asset value of RPAI, or any listed stock, is irrelevant to the price an investor can buy or sell shares.
Non-traded REIT managers and the boards of directors better be realistic when providing
valuation estimates, because investors rely on these for an accurate approximation of the value of their investment.
If a non-traded REIT expects to list the REIT’s shares on a stock
exchange as the planned exit strategy, its management better go the extra step to hone its
valuation estimate. I know it's impossible to accurately guess the price at which the market will value a non-traded REIT. No one is expecting valuation estimates to exactly match listing prices, but it's not hyperbole to say that a 50% disconnect is unacceptable. As shown by RPAI, it serves no purpose for a REIT to self-value at a price that has no relationship to what a REIT’s stock
could trade for when listed. Non-traded REIT independent directors need to do their job and demand pricing candor, even if it bruises REIT management egos.
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