Securitisation and discount to NTA under spotlight
Tie two addresses to the valuers’ Pan Pacific Congress together and you have two related steps in the changing shape of real estate investment. One was about securitising it, the other about the place of intangibles such as management contracts.
Woody Hanson (right), president of the US Appraisal Institute, said the most significant capital market effect on real estate investment was the turning of a privately owned asset base into a publicly owned one.
The two most recognisable forms in the US are the reits (real estate investment trusts) and commercial mortgage-backed securities (CMBS), with an umbrella reit the latest form to start taking shape.
“Between 1979 and 1998, equity reits had a total annual return of 14.4%, outpacing the return on direct property investments, which stood at 8.72%. Over 300 reits are publicly traded today, with total assets of $US130 billion dollars.”
The mortgage-backed securities industry is a more recent creation. After the savings and loans’ collapse and bailout in the 80s, the Resolution Trust Corp was charged with liquidating thousands of mortgages held by failed financial institutions. Among the obstacles facing this new agency were “the lack of any standard underwriting or due diligence criteria, as well as a lack of historical performance data on portfolio types and locations.
“This led to development of new risk-rating criteria, along with other due-diligence standards. As portfolio data and information formats were developed, appropriate software was also created. By the late 90s a global demand for commercial mortgage-backed securities had been generated. The CMBS market has grown from $20 million in 1994 to nearly $200 billion in 1999.”
Mr Hanson said these capital markets had led to a much more stable and efficient system based on markets rather than on banks. “CMBS and reits have changed the real estate valuation needs of issuers and investors. Commercial real estate investors are increasingly seeking information that provides detailed market analysis and insight into future revenue projections. Because securitisation offers less risk to investors, less weight is placed on historical value.
“Ratings agencies now play a key role in the securitisation process. Investment-grade CMBS are generally priced based on the rating assigned by the rating agency. The rating agencies are less concerned with the value conclusion than with the market data found in an appraisal, for example operating statements, rent estimates, tenant improvement allowances, leasing commissions.
“That data is used in an analysis that focuses on debt service coverage and loan-to-value ratios. In this context, value is determined by a cashflow analysis applied to a capitalisation rate based on property type, not from the appraisal report.”
All this greater market appraisal has meant that the expansionary phase of the US real estate market this time round has run three to five years longer than it ordinarily would have, he said.
Because of the demand for faster delivery of securities reports, and presentation of them in a more efficient manner, the Appraisal Institute is creating a commercial database for its members which is due to come into play in the first quarter of 2001.
“It seeks to provide transactional data from appraisers that can be accessed, queried and downloaded via the internet by customers who virtually span the globe.”
Mr Hanson said the institute was working with Britain’s Royal Institution of Chartered Surveyors and Australia’s valuers to create a single cohesive set of standards for valuers worldwide.
“This effort is being led by the International Valuation Standards Committee and will be unveiled this July during Valuation 2000.”
For the physical property industry, Mr Hanson said there would be more disciplined capital flows and construction patterns “thanks to the power of the public police, those 26-year-old analysts on Wall Street.
“Real estate is rapidly becoming a commodity. When Wall Street thinks of office, they think of square feet and a performance is derived out of that. Wall Street has imposed discipline on Main Street.”
Mr Hanson sees other changes coming, too, among them the advent of flat fees through the internet. He also expects the internationalisation of standard appraisal to raise the profile of a business he has been a partner in since last August, Integra Realty Resources. Because local firms can join the group but remain independent, he says it is already challenging the position of the big international agencies which operate through branches.
Role of intangible assets in listed trust valuations
Local Ernst & Young real estate group principal Gary Cheyne (left) presented a paper on valuing intellectual property and intangible assets, aimed at getting a true business value measure, but stopped short of its application in the property industry.
In a separate interview, Mr Cheyne said the value of intangible assets was an important factor in valuing listed property trusts and companies.
The common benchmark was to set the unit or share price against tangible asset value. But he said there was an inverse relationship between the size of a trust and its capitalisation rate.
“Is it a reflection of property? Maybe in part, but it’s probably also a reflection of the bigger trusts being able to attract the better people. What you’re seeing, in effect, is the valuation of human capital, the processes, the innovation and the ability to reflect in a better way the value of that intellectual capital.
“Human resource is the organisational assets. It’s also made up of brand and stakeholder relationships.”
Mr Cheyne’s point takes on importance in the debate over discounting, which happens to be more common than stock price premiums among New Zealand property listings. The property industry has argued that the sharemarket is wrongly valuing stocks by pricing at a discount to NTA.
Mr Cheyne’s finger points at the high value of management and its contracts, where there is a premium, and conversely at poor management where there is an apparent discount to NTA. In this assessment, physical property and property equities analysts might agree on tangible asset backing but the corporate value would be distinguished by the separate analysis of management intangibles.