Chapter 12 | Real Estate Company Analysis

Overview

For real estate companies, the aggregate corporate pro forma will generally differ from the sum of property-level cash flows.  The value of a real estate company can be greater or less than the value of its properties, as management can both add and destroy value beyond that of the properties.

Summary

The most significant differences between property- and company-level projections are: company-level overhead (at the property level, there is no line item for corporate general and administrative expense); corporate level debt (there may be debt not secured by real estate); income derived from non-real estate assets (e.g., from stocks, bonds, etc.); license fees (e.g., licensing of your company name for merchandising); and management fees, development fees, or leasing commissions from your properties or third party properties you may service.

It is important to note that Wall Street analysts do not roll up property-level pro formas to determine corporate values.  This is because analysts are typically not privy to such detailed private property information.  As a result, Wall Street analysts provide workable but imprecise financial descriptions of companies.

The following are key assumptions used in producing a company financial pro forma: acquisitions and developments and their income rates of return, dispositions, and revenue growth on existing properties.  These assumptions allow for modeling of aggregate property NOI.  Layering in corporate fees from noncombined affiliates, interest income and deducting G&A, we can calculate corporate EBITDA (earnings before interest expense, taxes, depreciation and amortization).

Funds from Operations (FFO) refer to funds available to equity.  Specifically, FFO equals NOI plus other income, minus overhead and interest payments but before depreciation, amortization and tax considerations.  FFO does not include cap ex, tenant improvements and leasing commissions.  So while two companies may have the same FFO, they may have very different free cash flows.  Adjusted FFO (AFFO) is FFO less estimated recurring cap ex, leasing commissions, and TIs.  AFFO is also known as Funds available for distribution (FAD).

A DCF valuation of a real estate company values the company’s ability to generate recurring cash streams.  This is no different from valuing any company.  To obtain the equity value of the company, one must deduct the value of liabilities.  Another method used is the cap rate approach, wherein a single cap rate is applied to the NOI roll-up of all properties.

Net Asset Value (NAV) is a common third approach to valuing a real estate company.  The NAV method assumes that corporate management adds no value.  The total value of a real estate company should include:  the aggregate capitalized value of the properties, the property management business, the development business, and the land held, plus the company’s cash position.  To reach the NAV, subtract the value of the company’s debt and other liabilities.  It is important to note that NAV fails to reflect hidden tax, debt, and environmental liabilities.  For example, prepayment penalties associated with debt are not deducted but are an important liability.

In the end, what makes a property company potentially more valuable than the value of its properties is people.  The people who work for real estate companies should be able to execute value-enhancing transactions on a consistent going-forward basis.

Questions

These are the types of questions you’ll be able to answer after studying the full chapter.

1. Why can the value of a real estate company be greater or less than simply the value of its properties?

2. What are the primary ways management can add value beyond the properties?

3. What is FFO and what does it include and not include?

4. Why are management agreement cash flows usually ascribed lower multiples than property cash flows?

5. Calculate the equity value for the following company. EBITDA in year 1 is expected to be $100M and is expected to grow by 1% for each of the next 5 years.  Cap Ex, TIs and LCs are expected to be $7M in year 1 and are expected to grow at 3% for each of the next 5 years.  Currently the company has $500M in debt and this is expected to remain constant going forward.  Assuming an exit in year 6, what is the equity value of the company today?  Assume a 10% discount rate and an 8% cap rate.

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Key Terms

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Corporate overhead expense related to the day-to-day operations of the company as opposed to the properties it owns.

A company’s earnings before interest, tax, depreciation, and amortization; calculated as Property NOI plus noncombined affiliate fee income, plus interest income from non-real estate assets such as bonds, minus company-level G&A expenses.

Funds from core operations available to equity owners on a pre-income tax basis.

A real estate company’s cash available for distribution to shareholders without a deterioration of its asset base.

A commonly-used approach to valuing a real estate company that assumes that management neither adds nor subtracts value.

Chapter Headings

  • Differences Between Property- and Company-Level Cash Flows
  • Company-Level Net Income Projection
  • Existing Properties Revenue Growth
  • Acquisitions and Developments and Rates of Return
  • Dispositions During the Period
  • Fees from Noncombined Affiliates
  • EBITDA
  • Debt Service Expense
  • Amortization and Depreciation and Impairments
  • Minority Interest
  • Value of a Company
  • Funds from Operations
  • Adjusted Funds from Operations
  • DCF Valuation
  • Cap Rate Valuation
  • Net Asset Value

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