The net asset value (NAV) is an excellent metric to use when assessing the value of a real estate investment trust (REIT).
A REIT is a security traded like regular stocks that invests solely in real estate holdings, properties or mortgages. The primary function of a REIT is to manage clusters of properties which produce income. Most of a REIT’s profits are distributed as dividends. The IRS recognizes a real estate company as a REIT as long as it distributes 90% of taxable profits as dividends. Meeting this regulation allows the company to avoid any liability for corporate income tax.
There are different types of REITs, but most are equity REITs, which focus on hard assets. These REITs typically own particular building types, such as office buildings, apartments or shopping centers.
The NAV is a valuable metric to utilize when assessing REITs. Book value and similar ratios such as price-to-book have been found to be very unreliable when applied to REITs. The use of the NAV is an attempt to bypass book value in favor of providing a more accurate estimation of actual market value for REIT holdings. To calculate the NAV, an analyst generates a subjective valuation of the REIT’s assets. One way of doing this is capitalization of the operating income, basing it on market rates. A cap rate for the present market is determined and used to divide a property’s operating income, with the resulting amount being the estimated market value. The market value minus any mortgage liabilities gives the NAV. The total NAV can be divided by outstanding shares to provide a per-share NAV.
The Bottom Line
While the NAV is a good metric to use when analyzing REITs, it is only as good as the analyst completing the assessment of each individual holding of the REIT. The calculation of the market value of assets must be carefully done in order to arrive at an accurate NAV for the entire REIT.