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NAV discount analysis using the “ appraisal reduction ”

NAV discount analysis using the “ appraisal reduction ”. Giacomo Morri – Roberto Lupieri presented at the 19 th Annual ERES Conference June 13th - 16th, 2012 Edinburgh. General outline on NAV Discount. Why do property companies trade at deviations from NAV?

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NAV discount analysis using the “ appraisal reduction ”

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  1. NAV discount analysis using the “appraisal reduction” Giacomo Morri – Roberto Lupieri presented at the 19th Annual ERES Conference June 13th - 16th, 2012 Edinburgh

  2. General outline on NAV Discount • Why do property companies trade at deviations from NAV? • What explanatory factors does closed end fund and real estate literature suggest? • Cross-sectional variations in deviations from NAV • Company-specific factors? • Time-specific factors? • The existence of premiums • Most ‘economic’ factors implicitly assume a discount (i.e. CGTL) • Changes over time in sector deviation from NAV

  3. Data sample • A ten-period database data 2007-2011 on quarterly basis: • 21 UK property companies (REITs) • 42 France property companies (SIICs) • Collected a large number of company specific and market variables mainly from databases • Bloomberg • Hemscott • Orbis • Morningstar

  4. Paper outline • Which are the explanatory factors for discount? • (traditional approach Rational and Behavioral) • How does gearing distort the estimation of NAV deviation? • (previous studies using unlevered discount) • How does market sentiment & property misestimation distort the estimation of NAV deviation? • (finally something new!)

  5. Nav Discount Literature (traditional approach) Rational explanations • Tax • Agency costs • Reputation • Gearing • Liquidity • Risk • Size • Performance • Dividend yield Behavioural explanations • Noise trading • Capital flows • Market segmentation • Sector discount effect • Not always consistency in findings • Different explanatory variables • Specifications often unstable • Low explanatory power

  6. Un-gearing the discount • Traditional discount calculation is distorted by gearing effect • A change in amount of borrowing produces a change in the NAV discount independently • We attempt to “clean” this effect from the calculation of NAV Target: better understanding of leverage effect

  7. Un-gearing the discount

  8. NAV discount Methodology • Traditional NAV discount • Unlevered NAV discount

  9. Appraisal Reduction Coefficient (ARC)

  10. Appraisal Reduction Coefficient (ARC)

  11. Average time-specific ARCs French ARC UK ARC

  12. Reducing appraisals A new approach partially based on Behaviour Approach • to eliminate the market sentiment from the NAV discount through an Appraisal Reduction Coefficient (ARC) • ARC artificially abates the discounts and leads to a recalculation of the relevant NAVs Target: better understanding of company specific factors

  13. Dependent variable & models Traditional NAV Discount Unlevered NAV Discount UK & France No Sentiment Adjustement Sentiment Adjusted NAV

  14. Dependent variable & models • Model UK1 Traditional NAV Discount • Model UK2 Unlevered NAV Discount • Model UK3 Sentiment Adjusted Traditional NAV Discount • Model UK4 Sentiment Adjusted Unlevered NAV Discount • Model F1 Traditional NAV Discount • Model F2 Unlevered NAV Discount • Model F3 Sentiment Adjusted Traditional NAV Discount • Model F4 Sentiment Adjusted Unlevered NAV Discount

  15. Independent variables • Gearing • Liquidity • Size • Management remuneration • Performance • Investment activity • Market sentiment

  16. UK results: correlation matrix

  17. UK results: traditional and unlevered

  18. UK results: Sentiment Adjusted

  19. France results: correlation matrix

  20. France: traditional and unlevered

  21. France results: Sentiment Adjusted

  22. Main findings & Conclusions Never! Seldom

  23. Final conclusions • Using ARC (M3 & M4) • Average Sector Discount becomes statistically insignificant at all the relevant levels in all, but one regression • ARC is useful in eliminating the market sentiment • Firm-specific factors are better able to explain NAV deviations: • Gearing • Investment activity

  24. Further research and extension • Longer time series & Pan European Sample • Bubble period (investment activity) • More transparency • Other countries • Appraisal Reduction “Sensibility” • NAV Discount does not depend on misestimation only, but how much it depend on ARC?

  25. Contacting Author Giacomo Morri, PhDSDA Professor & Director Master in Real Estate Accounting, Control, Corporate Finance & Real Estate Department SDA Bocconi School of ManagementMilan – Italygiacomo.morri@sdabocconi.itwww.propertyfinance.it

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