European REITs NAV discount: do investors believe in property appraisal?
| Published date | 04 July 2016 |
| Pages | 347-374 |
| DOI | https://doi.org/10.1108/JPIF-09-2015-0068 |
| Date | 04 July 2016 |
| Author | Giacomo Morri,Alessandro Baccarin |
| Subject Matter | Property management & built environment,Real estate & property,Property valuation & finance |
European REITs NAV
discount: do investors believe
in property appraisal?
Giacomo Morri
SDA Bocconi School of Management, Milan, Italy, and
Alessandro Baccarin
Bocconi University, Milan, Italy
Abstract
Purpose –The purpose of this paper is to analyse the NAV discount of European REITs listed in
France, the Netherlands and the UK between 2003 and 2014, considering elements of both “rational”
and “noise trader”approaches.
Design/methodology/approach –The analysis examines the hypothesis that discounts (premiums)
are the result of leverage, size, liquidity, risk, performance, investment activity and sentiment. The
regressions are initially run against the traditional NAV discount, subsequently using the unlevered
NAV discount measure introduced by Morri et al. (2005) in order to clean out the bias generated by the
level of leverage. The NAV discount is then adjusted for investor sentiment (appraisal reduction) with
the aim of better identifying firm-specific factors, considering distortions induced by sentiment.
Findings –Higher liquidity commands lower discounts for French REITs, while Dutch and British
REITs, which trade in markets characterized by a higher number of average daily transactions, do not
seem to feature discounts resulting from liquidity. For all three samples, operational risk and
performance are significant in explaining the NAV discount, the former having a positive relationship
with the discount, and the latter a negative one. When measured using the average sector discount,
sentiment has a profound effect on the discount, accounting alone for 10-15 per cent of theexplanatory
power of the model.
Practical implications –REITs listed in different markets behave differently. When the discount is
adjusted in order to remove the bias resulting from the level of debt, the relationship between leverage
and the unlevered discount becomes less pronounced in all cases.
Originality/value –The paper considers a new approach to NAV discount puzzle that takes into
account market sentiment and appraisals.
Keywords REITs, Leverage, Noise traders, Closed-end fund puzzle, Market sentiment,
NAV discount
Paper type Research paper
1. Introduction
Real Estate Investment Trusts (REITs) can be regarded as a special case of closed-end
funds, and hence an a priori deviation between their net asset value (NAV) and market
capitalization is to be expected. Although the existence of this double valuation is
nowadays accepted, the reason for this has not yet been resolved.
The present work, which may be located against the backdrop of the closed-end fund
discount literature, investigates the NAV discount puzzlefor REITs listed in France, the
Netherlandsand the UK between 2003 and 2014. First,the paper tests the hypothesis that
the link betweenthe price of a REIT share and its NAV per share canbe described using Journal of Property Investment &
Finance
Vol. 34 No. 4, 2016
pp. 347-374
©Emerald Group Publis hing Limited
1463-578X
DOI 10.1108/JPIF-09-2015-0068
Received 29 September 2015
Revised 21 January 2016
Accepted 20 March 2016
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1463-578X.htm
The authors are grateful to all participants at the 20th Annual ERES Conference (24-27th June
2015) in Istanbul for their valuable comments and suggestions on an earlier version of the paper.
All errors and omissions remain the authors’responsibility.
347
European
REITs NAV
discount
differences inREIT leverage, size, liquidity, operational risk, profitability and investment
activity. The extent to which the average discount to NAV across the REIT sector as a
whole plays a role in explaining changes in individual REIT discount to NAV has also
been included, as it provides a measure of market sentiment.
The work then carries out an unlevered NAV discount analysis, first de veloped by
Morri et al. (2005), in order to provide a more precise evaluation of the role of the factors
on NAV discount, removing the accounting bias generated by leverage in explaining
the discount. Finally, a new approach based on the concept of the appraisal reduction
coefficient (ARC), is attempted, and a new model is developed, in order to remove also
the distortion on the NAV discount created by market sentiment. We expect the
introduction of sentiment adjusted regressions to provide a cleaner picture of the effect
of fundamental factors on the discount (traditional metrics on NAV discount indeed
take into account the sentiment bias considering it as a factor for itself, and hence
cannot evaluate precisely its impact on other independent variables).
The paper is structured as follows. Section 2 introduces the theoretical framework of
the dual market, with REITs and direct investments. Section 3 reviews the past
literature focusing on the “rational”and on the “noise trader”approaches to the NAV
discount. Section 4 presents the data and the methodology. Section 5 then presents the
results of the NAV discount analysis by country and in positive and negative market
regimes. Finally, conclusions and closing remarks are provided in the last section.
2. Theoretical framework: the dual market for real estate
Real estate is a particular form of investment because an investor who wishes to obtain
exposure to it has two opportunities: investing in shares or bonds issued by a listed
property company or investing directly in properties. Since there are two ways of
becoming exposed to the real estate sector, there are also two markets, each with its
own features and rules. In direct property markets physical assets are traded privately
between investors: liquidity is often lacking and market valuations are mainly based on
past transactions. Moreover, the value of a property is not regularly updated and is
difficult to ascertain because transactions are not public and properties have different
features. Shares in listed real estate companies, on the contrary, are exchanged every
day both by professional and retail investors on regulated stock exchanges. They have
higher liquidity and, as for listed stocks, their valuation is based on cash flow
expectations. The share prices are public, and hence certain and continuously updated,
but are very noisy and unpredictable.
The existence of a dual market for real estate implies that real estate listed
companies, especially in the European markets, are subject to a double valuation: the
NPV, which follows the dynamic of the private property market, under which a REIT
NAV is obtained by subtracting the value of the liabilities of the REIT from the
appraised value of its underlying assets; and the market value, which follows the
dynamic of the stock market, through which investors provide an explicit and always
up to date valuation of the equity.
Understanding the relationship between pricing in the two markets has taken on a
new importance as the REIT sector has grown rapidly and as institutional investors
have come to play a more prominent role. Indeed, there are some significant differences
between these two markets, and this fact has interesting consequences. On the one
hand, financial markets, which continuously accumulate new information and
are forward looking, generate valuations that are more volatile (i.e. these valuations
feature a random error around the true, unobserved value) and change also on the basis
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