The net asset value (NAV) is one of the best metrics 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 that produce income. By law, the majority of a REIT's profits are distributed as dividends. The Internal Revenue Service (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.
- One of the best ways to analyze real estate investment trust (REITs) is with net asset value (NAV).
- NAV is used instead of price-to-book ratios and other book value measures.
- NAV seeks to figure out the actual value of the REIT’s holdings by taking the market value and subtracting any debts, such as mortgage liabilities.
Types of REITs
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. For equity REITs, they can either be publicly-traded, e.g. trading on the New York Stock Exchange, or public but not traded. As well, there are private REITs. Last but not least, there are mortgage REITs (mREITs), which
Mortgage REITs (mREITS) provide financing for income-producing real estate by purchasing or originating mortgages and mortgage-backed securities and earning income from the interest on these investments.
Benefits of NAV
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.
For example, book value is calculated as the purchase price less the depreciation. If a property is purchased for $100,000 and deprecation is $100,000 a year. At the end of year five, the accumulated depreciation is $50,000. Thus, from a book value perspective, the property is valued at $50,000 ($100,000 - $50,000). But, in reality, that's likely not the true value of the real estate. Thus, NAV takes into account the market value and subtracts the debts.
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 to arrive at an accurate NAV for the entire REIT.