Property-by-Property Valuation of Publicly Traded Real Estate Firms
Corgel, John B, The Journal of Real Estate Research
Abstract. Because the assets held by publicly traded real estate companies are infrequently traded, their values must be estimated to determine the relationship between share prices and net asset values for investment purposes. Alternative modeling approaches may be followed to accomplish these valuations, including income-based and transaction-based models. The real estate values of publicly traded firms are estimated in this study using a hedonic pricing model that combines the market's valuation of the fundamental characteristics of the assets with the specific characteristics of each asset being valued. After converting asset values to estimates of net asset values, the net asset values are compared to the market valuations of firms' equity claims. Valuations for two Hotel REITs provide information about market premiums commonly attributable to liquidity and REIT management.
The resurgence of REITs, with nearly 100 initial public offerings during the early 1990s, has renewed investor interest in how securities markets value publicly held real estate and the management of its productive use.1 Because REIT management is required to invest 75% of total assets in real estate, cash, cash items, and government securities to maintain tax-exempt status, REITs offer the opportunity to study relationships between valuations of real estate in the securitized and unsecuritized (property) markets.2 Such studies are challenging, in that the securitized claims trade continuously and the unsecuritized claims trade infrequently.
To serve the needs of REIT investors and explore academic interests in real estate market behavior, models must be introduced to estimate the values of the assets held by real estate firms.3 Popular asset valuation models have two forms; income-based and transaction-based models. A transaction-based hedonic model, matched with a large database of property transactions, is introduced here to estimate the values of the underlying assets of public-traded real estate firms. The value estimates from the model rely on the asset market's implicit pricing of property characteristics. Following the conversion of asset values to estimates of net asset values, net asset values are compared to the security market's valuations of firms' financial claims. Demonstrations, using data for two hotel REITs, provide information about how the model may be used to estimate market premiums often attributed to liquidity and management.
The remainder of this study is organized into four sections. The next section discusses issues surrounding public and private market valuation of real estate. Section three reviews the models used to value the underlying assets of publicly traded real estate firms. The hedonic pricing model is introduced and implemented in section four, including demonstrations using data for two hotel REITs. The final section presents the summary and conclusions.
Refinement of the Value Issue
The study of security market valuations of the underlying assets of firms has two dominant traditions. From one tradition, value questions emerge because of certain latent assets held by firms (Brennen, 1990). Specifically, can firms unlock hidden securities values associated with assets used (now or in the future) in the production of goods and services for their main lines of business (e.g., an office tower owned and occupied by IBM)? The second tradition focuses on value differences of firms relative to the values of assets held for investment, for which, the underlying assets have their own secondary markets. The classic valuation problem from this tradition is the closed-end mutual fund anomaly (Lee, Shleifer and Thaler, 1990). The valuation problem addressed in this study relates to both traditions, but as discussed below, is not perfectly aligned with either.
Brennen (1990) argues that, although the real estate owned by firms may contribute to earnings in amounts equal to rental savings, investors cannot easily determine these rental savings. …