Explaining the premium to NAV in publicly traded Australian REITs, 2008–2018
| Pages | 4-30 |
| DOI | https://doi.org/10.1108/JPIF-06-2019-0078 |
| Published date | 26 September 2019 |
| Date | 26 September 2019 |
| Author | Isil Erol,Tanja Tyvimaa |
| Subject Matter | Real estate & property,Property valuation & finance |
Explaining the premium to
NAV in publicly traded
Australian REITs, 2008–2018
Isil Erol and Tanja Tyvimaa
Queensland University of Technology, Brisbane, Australia
Abstract
Purpose –The purpose of this paper is to explore the levels and determinants of net asset value (NAV)
premiums/discounts for publicly traded Australian Real Estate Investment Trust (A-REIT) market during the
last decade. A-REITs were severely affected by the global financial crisis as S&P/ASX 200 A-REIT index-
listed property stocks experienced 47 per cent discount to NAV, on average, in 2008–2009 crisis. Since 2013,
A-REIT sector has exhibited a strong recovery from the financial crisis and traded at high premiums to date.
Understanding the relationship between pricing in the public and private real estate markets has taken on
great importance as A-REITs continue to trade at significant premium to NAV unlike their counterparts in
the USA and Europe.
Design/methodology/approach –This paper follows a rational approach to explain variations in NAV
premiums and explores the company-specific factors such as liquidity, financial leverage, size, stock price
volatility and portfolio diversification behind the A-REIT NAV premiums/discounts. The study specifies and
estimates a model of cross-sectional and time variation in premiums/discounts to NAV using semi-annual
data for a sample of 40 A-REITs over the 2008–2018 period.
Findings –The resultsreveal that A-REIT premiumsto NAV can be explainednot only by the liquidity benefit
of listed property stocks but also positive financial leverage effect. During the past decade, A-REITs have
followed an aggressive approach in financingtheir growth by using borrowed funds topurchase assets as the
incomefrom the property offsetsthe cost of borrowing and the riskthat accompanies it. Debt-to-equity ratio has
to be considered as an important source of NAV premiums as highly geared A-REITs that favoured debt
financing over equityfinancing traded at significant premiumsto NAV of their underlying real estate assets.
Practical implications –The paper includes implications for the REIT market investors. The regression
analysis shows that specialty A-REITs with a focus on creative market niches traded at higher premiums
compared with other property stocks, especially in the post-GFC recovery period. Specialty REITs are more
highly valued by the market than their traditional specialised counterparts (e.g. office and retail REITs), and
those pursuing a diversified strategy.
Originality/value –This paper presents an Australian case study as the A-REIT market provides a suitable
environment for testing the effect of financial gearing on the REIT premium to NAV. The study provides
empirical evidence supporting the importance of debt-to-equity ratio in explaining the variation in A-REIT
NAV premiums.
Keywords Australian REITs, Developer REITs, Gearing ratio, Premium to NAV
Paper type Research paper
Introduction
The Australian-listed property market has been a leading player in global real estate
markets over the past decades. The history of listed Australian Real Estate Investment
Trusts (A-REITs) can be traced back to 1971 when the first A-REIT was listed, and today
there are 43 REITs trading on the Australian Stock Exchange (ASX) with a total market
capitalisation of approximately $162bn[1]. The market is one of the most developed
REIT markets in the world (Stevenson and Dimovski, 2014), experienced tremendous
growth and investor interest following the crash of unlisted property funds in mid-1990s,
and consistently outperformed common stocks until the September 2008 financial crisis
(Yong and Singh, 2013).
The purpose of this paper is to explore the levels and determinants of net asset value (NAV)
premiums/discounts for the A-REIT market during the last decade. Pre-global financial crisis
(GFC) research indicates that A-REITs trade differently to most of their global counterparts,
Journal of Property Investment &
Finance
Vol. 38 No. 1, 2020
pp. 4-30
© Emerald PublishingLimited
1463-578X
DOI 10.1108/JPIF-06-2019-0078
Received 11 June 2019
Revised 30 July 2019
Accepted 1 August 2019
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1463-578X.htm
4
JPIF
38,1
consistently trading at a premium to their u nderlying NAVs. Japan and Thailand REITs
displayed similar characteristics (Liow and Li, 2006). However, pricing behaviour of A-REITs
has changed significantly in the last ten years, especially in the GFC period, shifting away from
overvaluation towards the undervaluation of property stocks, with values dropping to
47 per cent discount to NAV on average. The devastating effect of the GFC on the A-REIT
industry continued until the end of 2012, when the A-REIT market rebounded and shifted
again to trade at premiums to NAV and this has continued to date. Understanding the
relationship between pricing in the public and private real estate markets has taken on great
importance as A-REITs continue to trade at significant premium to NAV unlike their
counterparts in the USA and Europe[2].
This study contributes to the existing literature in several ways. First, although
Australia has a significant REIT market with a long history, there is no academic research
on investigating the pricing of A-REITs in regard to their underlying asset values. Since the
early 1990s, there has been considerable research devoted towards the understanding of the
link between public (securitised) and private (unsecuritised) market pricing of properties in
the US and European countries; however, to our knowledge, no other academic paper has
studied NAV-based pricing of A-REITs so far. Second, this paper presents a case study of
Australia as the A-REIT market provides a suitable environment for testing the effect of
financial gearing (or debt-to-equity ratio) on NAV premiums for the publicly traded REITs.
High levels of financial gearing (or debt-to-equity ratio) incurred during the sector’s boom
phase from 2001 to 2007 has been sustained after the September 2008 financial crisis with a
marginal decline. Our paper provides empirical evidence to support Adams and Venmore-
Rowland’s (1990) argument that debt-to-equity ratio has to be considered as a potential
influence on premiums and that there may be a positive relationship between the magnitude
of the premium to NAV and the level of gearing. Third, this paper explores if highly
focussed specialty A-REITs are more highly valued by the market than traditional
specialised portfolios (e.g. office, retail and industrial A-REITs), and those pursuing a
diversified strategy. We also study the impact of development activities on A-REIT stock
price premiums to NAV. Hence, in addition to widely studied conventional company-specific
factors behind the NAV premiums/discounts, we investigate whether specialty and
developer A-REITs outperformed their counterparts and traded at comparatively higher
premiums to NAV.
The listed property market in Australia has experienced higher volatility than other
asset classes over the last two decades. Further to the collapse of unlisted property trust
sector in mid-1990s, critical amendments to the Corporations Law provided for the
restructuring of the direct and indirect property component of the industry, and most funds,
pursuing the liquidity afforded by share-market listing, transformed into listed property
trusts (LPTs) or merged or both (Mees et al., 2005). After 2000, LPTs underwent significant
structural changes, including increased levels of international property acquisitions, a
change in business model, fluctuating debt levels, significant mergers and acquisitions and
a substantial shift to internally managed (or stapled) vehicles (Oliver, 2004)[3]. In March
2008, LPTs were renamed to A-REITs to be more consistent with international
classifications. A-REITs historically provided investors with a high yield, however, over
the last few decades structural changes drove yields even higher. While the rental income
from property ownership remained as the core driver, there was a shift towards deriving
additional return from property development and funds management activities. This
change in business model was a contributing factor in the increasing number of mergers,
such as the combination of the various Westfield entities into one vehicle in 2004. From 2003
to 2013, there was a substantial reduction in the number of A-REITS. The most significant
turning point in the sector was the GFC, where high gearing levels, high dividend payouts
and an increased focus on properties with less stable income streams resulted in significant
5
Explaining the
premium to
NAV
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