Although most people passively invest in multifamily real estate, there is a lot of legwork that goes into finding the proper investment. Before someone can take a truly passive role in a deal, they must first identify the deals or funds that are best aligned with their investment criteria.
One of the ways to evaluate an opportunity, at either the property-level or fund-level, is by looking at its net asset value. In this article, we highlight how net asset value can be used as a metric to compare the value of various multifamily real estate investments.
What is Net Asset Value?
Net asset value, or “NAV”, is a way to describe the value of an asset’s equity at a certain point in time. It can be used to measure the equity in an individual asset. It can also be used to value the equity associated with a portfolio of investments, such as a real estate fund that owns and operates multiple apartment buildings.
The higher the net asset value,
the more profitable an investment is said to be.
NAV is often used by investors looking to understand the total value of an asset less any outstanding debt or other property liabilities. The higher the net asset value, the more profitable an investment is said to be. This is because there is more revenue available, after debt and other liability payments, to return to investors. Upon sale, there will be more proceeds available to distribute to investors as well.
How to Calculate Net Asset Value
As used for multifamily real estate investing, the calculation for net asset value is rather simple.
As a rule of thumb, whenever investors hear the term “net,” it is a reminder that something is being subtracted from the value. In this case, liabilities are being deducted from the value of the asset.
“Total assets” is used because NAV can be used to determine the value of a single property (and any accompanying structures or property) as well as entire real estate portfolios.
Total assets can include, but are not limited to, the value of the actual real estate asset as well as any marketable securities, cash, accounts receivable and other related assets.
“Total liabilities” refers to any property-level debt, corporate or fund-level debt, accounts payable, taxes, insurance and any other outstanding liabilities associated with the asset (or portfolio of assets). Some investors will also subtract the value of any fixed or planned capital expenses when calculating NAV, but these can be difficult to ascertain unless the value of those capital expenses has already been firmly committed to as part of the annual CapEx budget.
What Influences a Property’s Net Asset Value
Anything that influences the individual components of the NAV calculation will impact a property’s net asset value. Some of these components can be controlled by the sponsor or investment manager, such as the type and amount of debt to employ. However, there are other factors that can influence NAV that are beyond the control of the ownership group. These uncontrollable factors are generally due to fluctuations in market conditions such as changes to area cap rates, interest rates, rental rates, vacancy and, inevitable changes to operating expenses.
How Changes to NOI Impact Net Asset Value
A property’s net operating income (NOI) is an important figure needed to calculate the market value of a cash-flowing real estate investment. The NOI divided by the cap rate is the primary formula for determining market value. Therefore, if the cap rate is held constant, then a property’s NAV will improve when NOI increases. Conversely, the net asset value will fall if the NOI decreases.
Therefore, investors looking to boost their NAV can do so by focusing on various physical and operational improvements that will correspondingly improve the property’s net operating income.
How Capital Markets Impact Net Asset Value
Capital markets (including both debt and equity markets) can have both a direct and indirect impact on a property’s net asset value. The most direct impact is on cap rates, which are routinely influenced by current interest rates.
Efficient capital markets will allocate capital efficiently, meaning the market will compare the risk and return across all available investment opportunities. If expected returns rise on investments with less risk than commercial real estate, then the expected returns on commercial real estate (both cap rates and the internal rates of return) will need to rise accordingly.
Capital markets (including both debt and equity markets)
can have both a direct and indirect impact
on a property’s net asset value.
Indirectly, the state of the capital markets will impact real estate investments in many ways. Generally speaking, if equity and debt are readily available at attractive rates, it is easier to start or expand a business, which leads to more demand for nearly all forms of commercial real estate. This, in turn, helps to improve occupancy rates and rental rates, which will therefore help to increase NOI.
Property-Level vs. Fund-Level Net Asset Value
As discussed above, NAV can be used to assess the value of a single property or it can be calculated at the fund level.
Calculating NAV at the property level is relatively straightforward, assuming one knows the current market value of the asset and the outstanding liabilities.
However, in commercial real estate, net asset value is most often used to determine the value of real estate mutual funds or real estate investment trusts (REITs). When used in this context, the NAV can be used to measure the total shareholder equity position. To do so, divide the fund’s net asset value by the number of outstanding units or shares. This resulting metric is what’s known as the “net asset value per share” or “NAVPS”. Typically, the higher the NAVPS, the more valuable a fund or REIT is said to be.
Calculating the NAVPS is important for any open funds, including real estate mutual funds and REITs, as this is the value used for determining the share price of the fund. Depending on the NAV of the fund, the fund will issue and redeem shares by pricing each accordingly.
For example, let’s say a multifamily REIT has a NAV of $100 million and has 10 million shares outstanding. The NAVPS would be $100. Therefore, an investor who purchases $1 million worth of shares would own 10,000 REIT shares. After the investor completes this purchase, the REIT would have a NAV of $101 million since the $1 million in shares was converted from a liability to an asset.
Of note, with REITs, the NAV is measured without factoring in any income taxes that someone would owe upon the sale of their REIT shares. Instead, the NAV for a real estate investment trust should be considered like that of the “price-to-book” ratio given that unrealized gains and losses of each property will be reported as part of the NAV calculation.
Calculating NAV at the fund level is no easy task, especially in terms of the reporting required for open-ended funds. Open-ended mutual funds and REITs are often required to report NAV every day. Calculating the net asset value each day is a specialized task generally handled by a fund accountant who closely monitors investment capital inflows and outflows, purchases and sales of investments, investment income, gains and losses, and ongoing fund expenses.
The fund’s updated NAV tends to be reported after the stock market closes each day and the fund accounting is complete. In short, the fund manager provides critical record-keeping and administration on behalf of investor shareholders.
Why is Net Asset Value Important to Commercial Real Estate Investors
Understanding a fund’s net asset value is particularly important for commercial real estate investors as they weigh their options as to how, where, and with whom to invest.
Unless investing in a specific real estate deal (via direct ownership, a joint venture, or a real estate syndicate), most people will invest their private equity into an investment company. The investment company (e.g., a REIT or mutual fund) will pool capital from many individual investors and then invest those funds in a wide range of securities or other assets.
The benefit to investing in an investment company, like a
mutual fund or REIT, is that it allows individuals to access multifamily
real estate deals that they would be unable to access on their own.
Each investor has a claim to the portfolio established by the investment company in proportion to the amount invested. Therefore, understanding the value of that fund is critical to calculating the value of someone’s individual shares in that fund.
The benefit to investing in an investment company, like a mutual fund or REIT, is that it allows individuals to access multifamily real estate deals that they would be unable to access on their own. These investment vehicles also allow individual investors to diversify their own portfolios by holding fractional shares of many different securities.
Example of Multifamily Net Asset Value
The most straightforward example of multifamily net asset value is to assume one knows a property’s current value, let’s say, $20 million. Then, let’s assume the property has an $8 million mortgage and roughly $3 million in other liabilities. The apartment building would be said to have a net asset value of $9 million ($20 million – $11 million).
One thing for investors to bear in mind is that a property’s net asset value is based upon a single snapshot in time. In reality, a property’s market value and liabilities will fluctuate – sometimes even on a daily basis. Therefore, the NAV reported one day may be different than reported the next day.
While the NAV for a single real estate asset may be reported on a monthly or quarterly basis, it is much more common for the NAV to fluctuate on a daily basis for REITs, real estate mutual funds, unit investment trusts (UITs), and other publicly-traded portfolios. Any open-ended fund is required to re-calculate its NAV at least once per business day, an accounting practice that generally occurs after the markets close. This stipulation does not apply to closed-ended real estate funds.
Here is how NAV might be used to calculate the value of a real estate portfolio.
Suppose a real estate mutual fund manages a portfolio of apartment buildings worth $120 million. Suppose the fund owes $4 million to its investment advisers and owes another $1 million for rent, wages due, and miscellaneous expenses. The fund has 5 million shares.
Using the NAV calculation, an investor can determine the value of each share associated with that real estate mutual fund.
NAV = $120 million (assets) – $5 million (liabilities) / 5 million shares = $23 per share
Of course, if the value of the apartment buildings goes up in value beyond $120 million, and liabilities remain the same, the value per share will increase accordingly.
Net Asset Value (NAV) vs. Net Present Value (NPV)
Net asset value (NAV) and net present value (NPV) are two terms that investors sometimes confuse. It is important to understand the difference, as NAV and NPV are two decidedly different metrics.
NPV is a way of converting all future cash flows into today’s dollars.
For example, if someone purchases an apartment building for $1 million and makes $100,000 in cash flow every year for five years, then sell the property for $1 million at the end of five years, the internal rate of return will be 10%. Simply put, the investor will have made 10% on their money, every year, for the past five years.
So how does that translate into NPV?
NPV is a calculation that takes into account the asset’s total revenue (both today and cash flows expected into the future) and then applies a discount rate to account for the riskiness of the deal as well as time (the duration of the hold period). NPV allows investors to make an apples-to-apples comparison of multiple investments based on the value of their money today, their initial investment into a deal, and the projected cash flow that deal will generate after the discount rate is applied.
The discount rate is determined by the investor. Each investor needs to have an idea of what return they are willing to accept. For example, an investor who wants a return of 8.0% will use that as the discount rate when calculating the NPV. A positive NPV means that the investor can expect to earn a return above their target threshold. A negative NPV means that the deal does not generate sufficient returns. An NPV of exactly zero indicates that the investor will have earned their exact rate of return, or discount rate, as originally anticipated.
Any prospective real estate investor will want to understand how a firm calculates the net asset value of the opportunity being presented. It is equally important to look at how a sponsor or fund manager plans to improve NAV over time. Thoughtful value-add strategies or additions to a multifamily real estate portfolio can strengthen returns on behalf of investors.
At Smartland, we are always looking for ways to boost investor returns. Are you considering a multifamily real estate investment? If so, contact us today to learn more about the tools we employ to deliver exceptional returns for our investment partners.