Although most people passively invest in multifamily real estate. There is a lot of legwork that goes into finding the proper investment. To take a passive role in a deal, one must first find the deals or funds that match their investment criteria.
One of the ways to evaluate an opportunity is by looking at its net asset value. This article shows how to use net asset value as a metric to compare the value of different 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 for example 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.
Investors use NAV to calculate the total value of an asset after subtracting any outstanding debt or property liabilities. People say that the higher the net asset value, the more profitable the investment is. 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.
Often times 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.
Individuals use “Total assets” because NAV calculates the value of a single property. Including any accompanying structures or property as well as entire real estate portfolios.
Total assets can include the value of the actual real estate asset In 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 deduct the value of any fixed or planned capital expenses when calculating NAV. However, these can be difficult to find out. This only applies if the annual CapEx budget already committed the value of those capital expenses.
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. The sponsor or investment manager can control some of these components. For example, 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 often due to fluctuations in market conditions . For example, 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
To calculate the market value of a cash-flowing real estate investment, it’s important to know the property’s net operating income (NOI). The NOI divided by the cap rate is the primary formula for determining market value. Therefore, when NOI increases, a property’s NAV will improve if the cap rate remains constant. 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. Especially those 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. Current interest rates routinely impact cap rates, which has the most direct effect.
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. This then 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 mentioned earlier, NAV can assess the value of a single property or calculate it at the fund level.
Calculating NAV at the property level is relatively straightforward. This is assuming one knows the current market value of the asset and the outstanding liabilities.
However, in commercial real estate, people mostly use net asset value 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 metric is what’s known as the “net asset value per share” or “NAVPS”. Often times, a fund or REIT is seen as more valuable if its NAVPS is higher.
Calculating the NAVPS is crucial for open funds, such as real estate mutual funds and REITS, because it determines 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.
REITS measure the NAV without taking into account the income taxes someone would pay when selling their REIT shares. Consider the NAV for a real estate investment trust like that of the “price-to-book” ratio. The calculation includes the reporting of each property’s unrealized gains and losses.
Calculating NAV at the fund level is no easy task, especially in terms of the reporting required for open ended funds. Regulators often require open ended mutual funds and REITS to calculate and report their NAV daily. Calculating the net asset value each day is a specialized task often times handled by a fund accountant. This is someone who closely monitors investment capital inflows and outflows, purchases and sales of investments, investment income, gains and losses, and ongoing fund expenses.
The fund calculates and reports its updated NAV after the stock market closes and after it finishes its accounting for the day. 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. People will often use it to make decisions about 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 NAV 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 note 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 the reported next day.
A single real estate asset may report its NAV monthly or quarterly, but REITS, real estate mutual funds, unit investment trusts (UITs), and other publicly-traded portfolios see daily fluctuations in their NAV much more often. Any open ended fund is required to re-calculate its NAV at least once per business day, an accounting practice that often occurs after the markets close. This stipulation does not apply to closed ended real estate funds.
Here’s 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. Then 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 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 helps investors compare multiple investments fairly by taking into account the current value of their money, the initial investment in a deal, and the estimated cash flow from that deal after accounting for the discount rate.
The investor determines the discount rate. 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 anticipated.
Any prospective real estate investor needs to know how a firm calculates the net asset value of the investment opportunity they present. It is equally important to look at how a sponsor or fund manager plans to improve net asset value 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.