nav discount analysis using the “ appraisal reduction ”
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ERES 20122 Giacomo Morri – Roberto Lupieri
NAV discount analysis using the “appraisal reduction”
Giacomo Morri – Roberto Lupieri
presented at the 19th Annual ERES Conference June 13th - 16th, 2012 Edinburgh
ERES 20122 Giacomo Morri – Roberto Lupieri
General outline on NAV Discount
• Why do property companies trade at deviations from NAV?
• What explanatory factors does closed end fund and real estate literature
suggest?
• Cross-sectional variations in deviations from NAV
– Company-specific factors?
– Time-specific factors?
• The existence of premiums
– Most ‘economic’ factors implicitly assume a discount (i.e. CGTL)
• Changes over time in sector deviation from NAV
2
ERES 20122 Giacomo Morri – Roberto Lupieri
Data sample
• A ten-period database data 2007-2011 on quarterly
basis:
– 21 UK property companies (REITs)
– 42 France property companies (SIICs)
• Collected a large number of company specific and
market variables mainly from databases– Bloomberg
– Hemscott
– Orbis
– Morningstar
3
ERES 20122 Giacomo Morri – Roberto Lupieri
Paper outline
A. Which are the explanatory factors for discount?
– (traditional approach Rational and Behavioral)
B. How does gearing distort the estimation of NAV deviation?
– (previous studies using unlevered discount)
C. How does market sentiment & property misestimation distort
the estimation of NAV deviation?
– (finally something new!)
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ERES 20122 Giacomo Morri – Roberto Lupieri
Nav Discount Literature (traditional approach)
Rational explanations– Tax– Agency costs– Reputation– Gearing– Liquidity– Risk– Size– Performance– Dividend yield
Behavioural explanations– Noise trading– Capital flows– Market segmentation– Sector discount effect
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•Not always consistency in findings
•Different explanatory variables
•Specifications often unstable
•Low explanatory power
ERES 20122 Giacomo Morri – Roberto Lupieri
Un-gearing the discount
• Traditional discount calculation is distorted by gearing effect
• A change in amount of borrowing produces a change in the
NAV discount independently
• We attempt to “clean” this effect from the calculation of NAV
Target: better understanding of leverage effect
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ERES 20122 Giacomo Morri – Roberto Lupieri
Un-gearing the discount
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A B
market asset value (A) 100 100
debt value (D) 0 12
NAV 100 88
market value (MV) 80 68
discount to NAV 20% 23%
enterprise value (MV + D) 80 80
Unlevered NAV (NAV + D) 100 100
Unlevered discount 20% 20%
ERES 20122 Giacomo Morri – Roberto Lupieri
NAV discount Methodology
• Traditional NAV discount
• Unlevered NAV discount
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ERES 20122 Giacomo Morri – Roberto Lupieri
a Property portfolio 800b Cash and cash equivalents 80c Other assets 120
d = a + b + c Gross Asset Value 1.000e Financial liabilities 400
f = d - e Net Asset Value 600g Market Value 450
h = g/f -1 NAV discount 25,00%i = g - f € Discount 150
j = i/a Appraisal Reduction Coefficient % (ARC) 18,75%k = a * (1-j) Sentiment Adjusted Property portfolio 650
l = k + b + c - e Sentiment Adjusted NAV 450
Appraisal Reduction Coefficient (ARC)
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ERES 20122 Giacomo Morri – Roberto Lupieri
C1 C2 C3 C4a Property portfolio 800 500 960 500b Cash and cash equivalents 80 50 80 100c Other assets 120 100 120 5
d = a + b + c Gross Asset Value 1.000 650 1.160 605e Financial liabilities 400 300 0 300
f = d - e Net Asset Value 600 350 1.160 305g Market Value 450 200 770 160
h = g/f -1 NAV discount 25,0% 42,9% 33,6% 47,5%i = g - f € Discount 150 150 390 145
j = i/a Appraisal Reduction Coefficient % 18,8% 30,0% 40,6% 29,0%Weighted Average ARC 30,3% 30,3% 30,3% 30,3%S.A. Property portfolio 558 349 670 349Cash and cash equivalents 80 50 80 100Other assets 120 100 120 5S.A. Gross Asset Value 758 499 870 454Financial liabilities 400 300 0 300S.A. NAV 358 199 870 154Market Value 450 200 770 160S.A. NAV discount -25,7% -0,6% 11,5% -4,1%€ S.A. Discount -92 -1 100 -6
Appraisal Reduction Coefficient (ARC)
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ERES 20122 Giacomo Morri – Roberto Lupieri
Average time-specific ARCs
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UK ARC French ARC
0,00
5,00
10,00
15,00
20,00
25,00
30,00
35,00
1/9/
06
1/12
/06
1/3/
07
1/6/
07
1/9/
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1/12
/07
1/3/
08
1/6/
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1/9/
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1/12
/08
1/3/
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1/6/
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1/9/
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1/12
/09
1/3/
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1/6/
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1/9/
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1/12
/10
1/3/
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-10,00
-5,00
0,00
5,00
10,00
15,00
20,00
25,00
30,00
35,00
40,00
1/9/
06
1/12
/06
1/3/
07
1/6/
07
1/9/
07
1/12
/07
1/3/
08
1/6/
08
1/9/
08
1/12
/08
1/3/
09
1/6/
09
1/9/
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1/12
/09
1/3/
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1/6/
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1/9/
10
1/12
/10
1/3/
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ERES 20122 Giacomo Morri – Roberto Lupieri
Reducing appraisals
A new approach partially based on Behaviour Approach
– to eliminate the market sentiment from the NAV discount
through an Appraisal Reduction Coefficient (ARC)
– ARC artificially abates the discounts and leads to a
recalculation of the relevant NAVs
Target: better understanding of company specific factors
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ERES 20122 Giacomo Morri – Roberto Lupieri
Dependent variable & models
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No Sentiment
Adjustement
Sentiment Adjusted
NAV
Traditional NAV
Discount
Unlevered NAV
DiscountUK & France
ERES 20122 Giacomo Morri – Roberto Lupieri
Dependent variable & models
• Model UK1 Traditional NAV Discount
• Model UK2 Unlevered NAV Discount
• Model UK3 Sentiment Adjusted Traditional NAV Discount
• Model UK4 Sentiment Adjusted Unlevered NAV Discount
• Model F1Traditional NAV Discount
• Model F2Unlevered NAV Discount
• Model F3Sentiment Adjusted Traditional NAV Discount
• Model F4Sentiment Adjusted Unlevered NAV Discount
14
ERES 20122 Giacomo Morri – Roberto Lupieri
Independent variables
1. Gearing
2. Liquidity
3. Size
4. Management remuneration
5. Performance
6. Investment activity
7. Market sentiment
15
ERES 20122 Giacomo Morri – Roberto Lupieri
UK results: correlation matrix
16
MGMTEXP AVG GEARING LIQUIDITY INVACT ROA SIZE
MGMTEXP 1.0000
AVG 0.0949 1.0000
GEARING (0.0779) 0.0829 1.0000
LIQUIDITY (0.3209) (0.2212) (0.0577) 1.0000
INVACT (0.0893) (0.0832) 0.3159 0.0987 1.0000
ROA (0.0347) (0.1587) (0.3413) 0.1083 (0.0327) 1.0000
SIZE (0.4808) (0.0812) 0.2141 0.4315 0.0841 0.0465 1.0000
ERES 20122 Giacomo Morri – Roberto Lupieri
UK results: traditional and unlevered
17
Model UK1 Model UK2
Coeff. P-value Coeff. P-value
Intercept 54.1014 0.0236 (119.516) 0.0304
GEARING 1.5064 + 0.0049 (0.3456) - 0.0047
LIQUIDITY 0.0540 0.1938 0.0016 0.8645
MGMTEXP (50.7851) 0.2393 (6.0051) 0.5335
INVACT 0.9256 0.2515 0.4308 + 0.0175
ROA 1.2814 + 0.0000 (0.0989) 0.1293
SIZE (49.9386) - 0.0048 7.1957 - 0.0740
AVG 1.1451 - 0.0028 0.3838 + 0.0000
Adj-R2 20.2910% 30.7355%
F-prob 0.000035 0.000000
Model1 Model2
Model3 Model4
No Sentiment Adjustement
Sentiment Adjusted NAV
Traditional NAV Discount
Unlevered NAV DiscountUK
ERES 20122 Giacomo Morri – Roberto Lupieri
UK results: Sentiment Adjusted
18
Model UK3 Model UK4
Coeff. P-value Coeff. P-value
Intercept 88.7416 0.0056 16.9376 0.8676
GEARING 2.2841 + 0.0015 (0.5571) - 0.0149
LIQUIDITY 0.0785 0.1571 (0.0029) 0.8699
MGMTEXP (61.6359) 0.2846 (37.9148) - 0.0413
INVACT 1.3447 0.2122 1.3899 + 0.0001
ROA 1.3078 + 0.0009 (0.3064) 0.0146
SIZE (80.0619) - 0.0008 (6.9868) 0.3527
AVG 0.0201 0.9683 (0.5225) - 0.0015
Adj-R2 21.8714% 39.0794%
F-prob 0.000011 0.000000
Model1 Model2
Model3 Model4
No Sentiment Adjustement
Sentiment Adjusted NAV
Traditional NAV Discount
Unlevered NAV DiscountUK
ERES 20122 Giacomo Morri – Roberto Lupieri
France results: correlation matrix
19
MGMTEXP AVG GEARING LIQUIDITY INVACT ROA SIZE
MGMTEXP 1.0000
AVG (0.0161) 1.0000
GEARING (0.0919) 0.1153 1.0000
LIQUIDITY (0.0739) (0.1342) (0.1368) 1.0000
INVACT (0.0489) 0.0869 (0.0126) (0.1073) 1.0000
ROA (0.1109) 0.0614 (0.1060) 0.0314 (0.2367) 1.0000
SIZE (0.3842) 0.0101 (0.0340) 0.1177 (0.0297) 0.0452 1.0000
ERES 20122 Giacomo Morri – Roberto Lupieri
France: traditional and unlevered
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Model F1 Model F2
Coeff. P-value Coeff. P-value
Intercept (64.7968) 0.2208 (28.0596) 0.4683
GEARING (0.0404) - 0.0041 (0.0222) - 0.0311
LIQUIDITY (0.0250) - 0.0317 (0.0117) 0.1696
MGMTEXP 2.8220 0.6393 (2.8857) 0.5124
INVACT 0.4673 + 0.0009 0.2919 + 0.0043
ROA (0.6566) 0.2674 (1.1297) - 0.0094
SIZE 2.3921 0.5723 0.7511 0.8085
AVG 1.1539 + 0.0000 0.7734 + 0.0000
Adj-R2 54.2518% 51.9246%
F-prob 0.000000 0.000000
Model1 Model2
Model3 Model4
No Sentiment Adjustement
Sentiment Adjusted NAV
Traditional NAV Discount
Unlevered NAV DiscountFrance
ERES 20122 Giacomo Morri – Roberto Lupieri
France results: Sentiment Adjusted
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Model F3 Model F4
Coeff. P-value Coeff. P-value
Intercept (94.3886) 0.1874 (47.1788) 0.2708
GEARING (0.0556) - 0.0035 (0.0039) 0.7267
LIQUIDITY (0.0305) 0.0530 (0.0131) 0.1653
MGMTEXP (1.9111) 0.8145 (1.4286) 0.7695
INVACT 0.6447 + 0.0007 0.4073 + 0.0003
ROA (0.9017) 0.2602 (1.5571) - 0.0013
SIZE 3.7779 0.5097 1.5772 0.6456
AVG 0.1952 0.3692 0.1741 0.1812
Adj-R2 49.5817% 52.6864%
F-prob 0.000000 0.000000
Model1 Model2
Model3 Model4
No Sentiment Adjustement
Sentiment Adjusted NAV
Traditional NAV Discount
Unlevered NAV DiscountFrance
ERES 20122 Giacomo Morri – Roberto Lupieri
Main findings & Conclusions
22
M1Uk M2Uk M3Uk M4Uk M1F M2F M3F M4F
Gearing + - + - - - -
Liquidity -
MgntExp -
Invact + + + + + +
Roa + + - -
Size + + -
Avg + + - + +
Never!
Seldom
ERES 20122 Giacomo Morri – Roberto Lupieri
Final conclusions
• Using ARC (M3 & M4)
– Average Sector Discount becomes statistically insignificant at all the
relevant levels in all, but one regression
– ARC is useful in eliminating the market sentiment
– Firm-specific factors are better able to explain NAV deviations:
Gearing
Investment activity
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ERES 20122 Giacomo Morri – Roberto Lupieri
Further research and extension
• Longer time series & Pan European Sample– Bubble period (investment activity)– More transparency – Other countries
• Appraisal Reduction “Sensibility”– NAV Discount does not depend on misestimation
only, but how much it depend on ARC?
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ERES 20122 Giacomo Morri – Roberto Lupieri
Contacting Author
Giacomo Morri, PhDSDA Professor & Director Master in Real Estate Accounting, Control, Corporate Finance & Real Estate DepartmentSDA Bocconi School of ManagementMilan – Italygiacomo.morri@sdabocconi.it www.propertyfinance.it
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