Valuations of Large Publicly Traded Real Estate Companies and their Asset Portfolios.

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1 Dept of Real Estate and Construction Management Master of Science Thesis no. 478 Div of Building and Real Estate Economics Valuations of Large Publicly Traded Real Estate Companies and their Asset Portfolios. - How are they Correlated? Author: Ted Söderlund Supervisor: Han-Suck Song Stockholm 2009

2 Master of Science thesis Title: Authors Department Master Thesis number 478 Supervisor Han-Suck Song Keywords Valuation of Large Publicly Traded Real Estate Companies and their portfolios. How are they correlated? Ted Söderlund Department of Real Estate and Construction Management Division of Building and Real Estate Economics Real Estate Valuation, Real Estate Shares, IFRS, IAS 40, Market Value, Private Property Market, Correlation Abstract Since 2005 all publicly traded companies have to apply the IFRS in their accounting. The publicly traded real estate companies need to estimate the market value on their property for each quarter of the year. An increased or a decreased market value on the property portfolio will directly affect the income statement. The IFRS have not been used during a downturn in the economy before. In the media in Sweden, many discussions are taking place around the subject that the real estate companies are not writing down the values of their property enough. Different methods used to value real estate and stocks have been reviewed. The most used method to value both real estate shares and also their portfolios is the discounted cash flow model. This study has reviewed the seven largest publicly traded real estate companies in Sweden. It studied how their portfolios (market valued according to the IFRS) have developed in comparison to their shares both as individual companies and as a total of all the companies and their total portfolios. Correlations between the shares, their market valued portfolios and a stock market index has been done. The data included are 17 quarterly reports for each of the real estate shares. The data start with the last quarter 2004 and end with the first quarter 2009 and use the capital growth each quarter. As a stock market index the OMX S30 has been used. The correlation studies show that the real estate shares are more correlated to OMX S30 than to their own property portfolios.

3 Acknowledgement I want to thank my dad, Christian Söderlund, for all his support during my studies at the KTH but also during past studies. All our discussions, the proof reading of my work and all the time Christian has put down to help me with my studies have been of great importance to me. I also want to thank my mother, Anne Söderlund, who always has supported me and also helps me to view life from a different angle. I wish to acknowledge my girlfriend, Andrea Stenlo, for her patience with me when I have had a lot to do at school but also at work. Last but not least, I want to thank my supervisor, Han-Suck Song, for his help with this master thesis. Stockholm, June 2009 Ted Söderlund

4 Table of Contents 1 INTRODUCTION BACKGROUND OBJECTIVE METHODOLOGY DELIMITATIONS OF THE STUDY THEORY VALUATION Real Estate Valuation Valuation of Stocks and Companies Real Estate Valuation According to IFRS Real Estate Investment Trust Efficient Market Hypothesis Liquid and Illiquid Assets Investment Theory THE MEDIA S VIEW OF THE REAL ESTATE COMPANIES ANALYSIS OF THE VALUATIONS THE REAL ESTATE STUDY DATA INPUT RESULTS AND ANALYSES FROM THE STUDY CONCLUSIONS BIBLIOGRAPHY APPENDIXES...34

5 1 Introduction 1.1 Background Since 2005 all Swedish publicly traded companies must use the new accounting standards, called the International Financial Reporting Standards (IFRS). According to these standards all assets are supposed to be valued at market values in the financial reports. An increase or a decrease in the value of an asset should be taken up in the income statement of the company. After the introduction of IFRS the values of assets generally increased around the world. The ongoing financial crisis, which started during the summer of 2007, has broken this trend. Now it is harder for many companies to borrow money. Most companies and their assets have decreased in value because of the crisis. In Sweden investors seem to be unsure of the future value of different real estate assets. The last quarter of 2008 the transaction volume decreased with 40% compared to the same quarter (Gorosch (Inc.), 2009) Fewer transactions show that the buyers and sellers do not value the properties at the same value and also make it harder to value the properties at market value. Another problem has been the financing difficulties for the buyers due to the financial crisis. The large real estate asset companies listed on the mid and large cap on the Stockholm stock exchange have just marginally adjusted their prices down on their properties, according to Björn Wilke s article in the financial paper Dagens Industri on the 12 th of November According to Wilke the seven largest real estate asset companies on the Stockholm stock exchange showed in their third quarter reports a decrease of two per cent on their property values in average for the three first quarters of However, the investors of the stock market value their properties 14 per cent lower compared to how the real estate companies value their properties in the reports. Since these companies have debts an additional decrease in the property value of 14 per cent would lead to a decrease in equity from 62 to 43 billion SEK (Wilke, 2008, p. 5

6 10). The Carnegie real estate index has decreased with 50% during the last year and Professor Stellan Lundström argues that this means that the properties have decreased in value with about 20% (2008, p. 4). Commercial real estate is either bought on the private property market or indirectly on the public property market. Real estate is bought on the private property market when a whole property is changing hands and on the stock market shares of real estate asset companies are traded. (Geltner & Miller, 2007, p. 605) Different ways of valuing real estate are used. First, the real estate companies can value their assets internally, externally or by a combination of internally and externally to reach the market value of a property needed according to IFRS. Second, buyers and sellers on the stock market estimate the value of a traded company daily. Estimating the value on real estate is not an exact science and may differ. However, the equity values of real estate asset companies and the stock market values seem to deviate. We have seen many articles in the media during the last year that claim that the real estate companies have not decreased their property values enough. Why do the values differ? Are different valuation methods used for valuing the shares and the assets of real estate companies? Or are the real estate shares more affected by what is happening to the stock market in general than to their own property portfolios? This master thesis will do a comparison of the valuation methods used to value real estate shares and their assets. It shall be analyzed whether the different methods can explain why the values differ between the real estate shares and the market valued assets of their portfolios. It will investigate how the real estate companies and their own property portfolios have developed and how they are correlated with each other and the stock market in general. 6

7 1.2 Objective This master thesis will hopefully give an understanding of some differences between the IFRS valuations of properties and the valuations of publicly traded real estate companies in Sweden. Even though the methods to value these properties and companies seem to be the same there is still a difference in the value. The goal is to try to understand why. The study will focus on what drives real estate shares. Are the real estate shares most correlated to their own real estate portfolios or is the correlation larger with the stock market in general? The performance of shares of real estate companies, their assets, the property price index and shares in general will be shown and compared. 1.3 Methodology The methodology used in this master thesis will be quantitative. Correlation analyses will be done. The study will include historical data of the seven largest real estate asset companies traded on the Swedish stock market, the values of their assets, a real estate index and a Swedish stock market index. The main objective of the analysis is to see how these values are correlated. 1.4 Delimitations of the Study The companies that this thesis will study are the seven largest real estate asset companies quoted on the Stockholm stock exchange. The shares are traded on the mid and large cap lists of the exchange. The seven companies are: Atrium Ljungberg, Castellum, Fabege, Hufvudstaden, Kungsleden, Wallenstam and Wihlborg. Other property companies will not be included in this study. However, the SFI/IPD Swedish Property Index and the NASDAQ OMX 30 index will be used in the study. 7

8 2 Theory 2.1 Valuation When valuing companies and assets a variety of methods could be used. In this part the most commonly used methods will be explained. It is divided between the valuation of real estate, the valuation of stocks and companies, the valuation of REITs and the estimations of market values according to IFRS. The chapter will also include other theories important for the study Real Estate Valuation When valuing real estate there are three approaches that are often used: the cost approach, the sales comparison and the income capitalization approach. The cost approach estimates the value on a property by the cost of building a new comparable property. The cost is then adjusted for differences between the subject property and the estimated cost of building a new property. Examples of adjustments are standard and age of the property. The adjusted cost is the estimated value of the property in this way of valuing a property. (Geraci, 2001, p. 349) This valuation method could be used when a property is hard to value. An example could be a prison where there are no comparable sales or when it is hard to value the income of the property. The sales comparison approach uses the values of comparable properties that have been sold or are listed for sale. The comparable variables are then adjusted for differences to the subject property that is being valued. Adjustments in value are done for example as to differences in location, size and time. If there are regular transactions in the area and if the properties do not differ much from each other then this way of valuing a property is probably the easiest and the least time consuming approach. If the property market is at its peak the calculations with this method could show that the valued property is a good investment. The sales comparison approach is 8

9 a good valuation method to show the present market value but it does not show how good an investment it is in the long run. (Geraci, 2001, p ) Commercial real estate is often bought as an investment to produce income. In the income capitalization approach the income that the property generates is in focus. The income capitalization approach mainly includes the discounted cash flow (DCF) and the direct capitalization analysis. (Geraci, 2001, p. 471) When using the DCF valuation method all the future cash flows that the property is expected to have are discounted back to the present time with a discount rate that is affected by the risk of the investment. A higher risk premium will lead to a higher discount rate and therefore a lower present value for the investment. A problem with this method is that small changes in important variables like the exit yield, the discount rate or the expected net operating income will have a relatively large influence on the value of the property. Valuation is not an exact science and when one is valuing a property one must try to estimate the future. Hence, different investors will have different estimates for the future that will also affect the expected value of a property. (Geraci, 2001) The direct capitalization method originates from the Gordon s growth formula, which will be explained later in the text. With the direct capitalization method one uses the subject property s initial year s net operating income (NOI 1). It is divided by the capitalization rate (cap rate or yield). By dividing these two variables one gets an estimated market value. The cap rate equals the discount rate (r) minus the growth rate (g). (Geltner & Miller, 2007, p ) Market Value= ( NOI 1 / cap rate ) or Market Value= ( NOI 1 / ( r g )) This valuation method is not as time consuming as the DCF approach but it does not take as many factors into consideration. However, one assumes that the discount rate and the growth rate will be the same for eternity. The direct capitalization method is also often used in the DCF valuations to calculate what the property is worth at the end of the investors planned investment horizon. 9

10 Hence, the method can be used to calculate the terminal value of a property in five or ten years. (Geltner & Miller, 2007, p. 244) When valuing an investment property the most common ways are by using the sales comparison or the income capitalization approach. Either one of these methods is used but it might be good to use both of them when valuing a property. If the values differ much then one might suspect that something is wrong with the calculations, estimates, comparables or that the property market might be over- or undervalued Valuation of Stocks and Companies The most used valuation method to value companies in general is the DCF method. (Koller, Goedhart, & Wessels, 2005, p. 67) When valuing companies one is estimating the expected future of the companies. Important valuation factors in the DCF approach are to estimate the future cash flows, the return on invested capital (ROIC), the growth rate and the weighted average cost of capital (WACC). (Koller et al., 2005, p. 371) After these factors and many others have been estimated all the future cash flows are discounted back to a present value that will provide us with a value of the company. As mentioned earlier in the text, the DCF method is also used for valuing investment properties. The constant growth formula is one other way to reach the present value or market value of a company. It uses the companies initial dividend (DIV 1) and divides it with the discount rate (r) minus the growth rate (g). Market Value = ( DIV 1 / ( r g ) Multiples are also used for valuing companies. This is a rather easy way of valuing a company since it is not as time consuming as the DCF method. When one uses multiples to do a valuation it is not needed to do as many predictions of the expected future of the company. Multiple valuations could be done by assuming that the subject company might have the same return on invested capital (ROIC), growth or earnings as comparable companies in the industry. (Koller et al., 2005, p. 67) 10

11 If the value one receives from the DCF analysis is far from the market value one might expect that it is something wrong with the analysis. Multiple analyses are a good way of controlling that the DCF analysis is realistic. Even though a multiple analysis might not be as accurate as the DCF analysis it is a good way of comparing how other companies in the same industry are valued. Multiple analyses also give a good picture of the current market valuations of companies. The DCF analysis is not just a usable method for valuing companies in general; it is also a common method to value income producing real estate companies. Multiple analyses can be compared to the comparable sales approach and the direct capitalization analysis that is often used in real estate valuations. Both of these methods are used to see what comparable companies or properties have been sold for and if the DCF valuation is realistic. It is also a good way of seeing if a company or property is worth to buy i.e. will it generate enough income to be profitable at this current market price Real Estate Valuation According to IFRS Since 2005 all publicly traded companies in the European Union (EU) have to apply the International Financial Reporting Standards (IFRS) in their accounting. The standard is used to get a better transparency about companies financial positions and results. ( Internationell redovisningsstandard i Sverige IFRS/IAS, 2006, p. 3-7) When all companies in the EU use the same standard it will provide a common language instead of using different standards as before. (Nordlund, 2008, p. 9) According to the IFRS there are two standards for properties; IAS 16 and IAS 40. IAS 16 is used for property, plant and equipment while IAS 40 is used for investment property. Since this master thesis is investigating the valuation of investment property the IAS 40 will be the one of most interest. According to IAS 40 investment property is a property that generates rental income or a capital gain, or both of these two factors. A fair value shall be used in the balance 11

12 sheet for the investment property. If the fair value increases or decreases the change should be reported in the income statement. A cost model could also be used. It is the historical cost minus deprecation. However, if the company uses the cost model a fair value is still required to be stated for the property. In IAS 40 a fair value is explained as: The fair value of an investment property is the price at which the property could be exchanged between knowledgeable, willing parties in an arm s length transaction. (International Financial Reporting Standards, 2008) In IAS 40 it is stated that the best evidence of fair value is what similar properties are sold for in an active market. Examples of factors for similar properties are: location, condition, leases and other contracts. The differences are used to value the subject property up or down in price compared to what the other properties have been sold for. Meaning that the best valuation approach according to IAS 40 would be the comparable sales approach. However, IAS 40 also states that the fair value could be given by using the DCF valuation, which is the income approach. The cost approach could in some cases be used if there is an unusual property where there have been few transactions. (Nordlund, 2008, p.53) Nordlund (2008) has looked at Swedish real estate companies to see what methods they use when estimating the market value according to IFRS. Nordlund also controlled whether the companies that need an IFRS value do the valuations internally or externally. The results could be seen in table 2.1. His study found out that the DCF method or a combination of the DCF and a comparable sales method are most often used when estimating the market values of the companies portfolios. Only two companies out of the 14 chosen companies in this study used the direct capitalization method. It is also interesting that in all companies the income approach was used (since both the DCF and the direct capitalization method belong to the income approach). As the table 2.1 shows, most companies let an external firm do at least some of their valuations. Only three out of 14 companies do all their valuations themselves. From an investor s perspective it is, of course, better if an external valuation firm estimates the market values because it probably gives a more objective picture of the market values. 12

13 Table 2.1 Who values and what methods are used to calculate IFRS values in Sweden? Source: (Nordlund, 2008, p. 83) Real Estate Investment Trust Real Estate Investment Trusts (REITs) are traded on the stock market around the world. In the United States the REITs main advantage compared to shares is that REITs have tax advantages. They are valued with the DCF model as the other firms traded on the stock exchange. (Geltner & Miller, 2007, p. 586) The Net Asset Value (NAV) or the market value is calculated for REITs in order to estimate how much the REITs underlying assets are worth. When calculating the NAV of a real estate asset company one should value all the properties, in the portfolio, as to what they would currently be sold for if they were sold and then subtract the debt. The NAV of the company is compared to the total share value of the company. The NAV per share can also be compared to the share price. If the NAV is higher than the share price then there is a discount and if the NAV is lower than the share price there is a premium on the share price. (Geltner & Miller, 2007, p. 277) Geltner and Miller (2007) show a study made in the United States where they compare the REITs, the NAVs and the ratios between these two variables over the period from 1990 to See figure 2.1 below. It shows that the REITs and the 13

14 NAVs are not valued equally and do not move together. The ratios between the REITs and the NAVs fluctuate over time. Over some periods there are discounts and during other periods there are premiums in the share price. Figure 2.1 REITs share price vs. private property NAV Source: (Geltner & Miller, 2007, p. 278) The NAVs of the REITs, in the above study, are calculated on a static portfolio of existing real estate while the REIT prices are determined by the stock market. The stock market mainly values the REITs by the future cash flows and growth opportunities of the assets underlying the REITs. (Geltner & Miller, 2007, p. 278) If the share prices of the REITs would just have a discount or a premium compared to the NAVs in the study one might come to the conclusion that these two cannot be compared or that this is because a number of different factors. However, it is interesting that the ratios fluctuate over time; sometimes there is a discount and other times there is a premium on the REITs in relation to the NAVs. These relationships could be seen in figure 2.2 below. By looking at this figure it seems as though the discount and premium valuations move in cycles. 14

15 Figure 2.2 REITs share price premium to NAV Source: (Geltner & Miller, 2007, p. 606) Geltner and Miller (2007, p. 605) argue that the REIT/NAV ratio has a tendency to average out around one in the long run but in the short run there will be differences between the value of the REIT and the underlying asset. The reason that the ratio is around one in the long run is according to Geltner and Miller because of the capital flow from one market to another one. Meaning that, when the REITs are valued higher than the underlying property then investors tend to sell REITs and buy real estate at the private property market and the other way around. In the United States the share prices of the REITs often lie ahead in time of the private property market. The REITs seem to show the trend or the way that the private property market will go. The time range has been from one to three years where the REITs have been ahead in time. If the share prices of the REITs are above the NAVs then it symbolizes that the stock market predicts that there are growth opportunities for the underlying assets. Vice versa, if the NAVs are higher than the share prices of the REITs then the stock market assumes that the prices on real estate will decrease. (Geltner & Miller, 2007, p ) 15

16 2.1.5 Efficient Market Hypothesis According to the Efficient Market Hypothesis changes of stock prices are independent of one another. It is also said that the stock prices follow a random walk. There are three different levels of market efficiency. According to the weakest form of market efficiency it is believed that investors cannot constantly make profit from looking at historical data. The next level of market efficiency includes as the previous one all historical information but also information about events that will occur. Examples of such information are: information about companies estimated earnings and dividends as well as macroeconomic information like the estimated inflation rate. According to the strongest form of market efficiency all the information that could be gathered is used for an analysis of the company and the economy. Still it is believed that it is impossible to constantly perform better than the rest of the investors. If an investor would perform better than the market it would not be because of talent it would rather be because of luck. (Allen, Brealey & Myers, 2006, p ) Liquid and Illiquid Assets On liquid stock markets one should be able to buy and sell assets whenever one wants to. However, transactions on the private property market are normally more illiquid, more expensive, more time consuming and the market values are harder to estimate. (Geltner & Miller, 2007, p ) On different stock markets around the world more or less liquid assets are traded. The larger companies do often have shares with better liquidity than smaller companies. As to liquid assets there are more buyers and sellers involved in the auction. This leads to a smaller difference between what the seller is willing to sell for and what the buyer is willing to buy for than for an illiquid asset. Also the transaction volume is generally larger for liquid assets. Commercial real estate on the private property market is seen as illiquid assets compared to liquid real estate assets traded on a stock market. 16

17 During extreme markets, for example when bubbles or depressions occur in the economy, investors are more optimistic or pessimistic than normally. Then the market values for assets are higher or lower than what is common. Hence, the market values on liquid stocks are set daily no matter what market it is. Transactions of real estate assets on the private property market can be compared to illiquid stocks. Then the buyers and sellers have offers that are further away from each other as to what they believe can be a reasonable price for the asset. This often leads to lower transaction volumes and then it is also harder to estimate the market value Investment Theory Investment theory argues that the purpose of accounting is to give the investors, the shareholders and the creditors, the information that is needed. The more relevant information the analyst receives from the accounting the better analysis of the company he or she will be able to do. Most shareholders have little ability to affect how the company will perform and for them most of the information that they need can be found in the company reports. Also from the perspective of the banks and other creditors, accounting is of importance to judge the company s ability to generate income and repay the debt. (Nordlund, 2008, p.25) 17

18 3 The Media s View of the Real Estate Companies The recent global downturn in the economy is the first downturn since the IFRS was introduced in Sweden. The question whether the real estate companies have decreased their real estate values enough has been a current topic in the media in Sweden. Most articles and studies have come to the conclusion that the companies should value their property portfolios lower than what they did in Examples of articles in the media are, first Björn Wilke s article in the daily financial paper Dagens Industri on the 12 th of November Wilke shows that for the three first quarters of 2008 there have only been write-downs of about two per cent in average of the asset values for the seven largest quoted real estate companies. Additional write-downs of in average 14 per cent on their property portfolios would be needed for the companies equity to match the total share value. According to Wilke s study, Hufvudstaden is the company that for the three first quarters of the year 2008 had done the largest write-down in the group. The write-down was five per cent for the period and according to the stock market Hufvudstaden only needed to do additional write-downs of one percent to be in equilibrium. Wallenstam and Fabege, on the other hand, had only done write-downs of one to two per cent for the period. These companies needed to do extra write-downs of 23 per cent to be in equilibrium with the stock market s valuations. The results from Björn Wilke s study for the different real estate companies can be seen in the Table 3.1 below. Table 3.1 The study in the paper Dagens Industri of the different views on the real estate values. Source: (Wilke, B, 2008, p. 10) 18

19 Second, the weekly paper Veckans Affärer had an article on the 16 th of March 2009 that also argues in a similar way as the one mentioned in Dagens Industri. Veckans Affärer meant that 15 real estate companies with shares that are traded on the Swedish stock markets needed to do additional write-downs of 15 per cent or by 30 billion SEK compared to 9,5 billion SEK in write-downs for these companies during The magazine Veckans Affärer, also wrote that the real estate consultant Jones Lange LaSalle has estimated that the transaction volumes have decreased with 76 per cent for the first quarter of 2009 compared to the same quarter If the real estate companies would start to increase there write-downs on their portfolios this will lead to less equity for the companies and could, according to the article of Veckans Affärer, lead to foreclosures for the real estate companies with the highest debt ratios. Out of the 15 companies that the magazine has studied Veckans Affärer estimated that nine are well prepared for worse times. 19

20 4 Analysis of the Valuations When valuing companies, either listed or not, the DCF analysis is the most common method that is used. (Koller et al., 2005, p. 67) The DCF method is also used when valuing income producing real estate assets. According to Nordlund (2008, p. 83) most large real estate asset firms use the DCF method in order to value the assets. If properties in a real estate company as well as their shares would be valued according to the income capitalization approach and thus by the DCF method one might expect that they should provide values that do not differ much. Investors may use the DCF method to see how much a property can be worth for them. The DCF is the foundation for what investors are willing to pay. The price that the property is sold for is affected by what net present value the DCF method reaches because this is the price that investors normally are willing to pay. This means that the present value of the DCF analysis and the comparable sales price should be alike. Let us assume that real estate stocks are traded on an efficient market. Then according to the Efficient Market Hypothesis the prices that these shares are traded at reflect all possible information that is available. Since private property is an illiquid asset one could assume that the more liquid real estate asset stocks would indicate a price trend for the private property market. Perhaps the development of the share prices has shown a trend for how the future market values will develop. In theory, if investors would think that share prices of real estate asset companies are overvalued compared to the private property market then they would sell the stocks and buy the private real estate. And if they thought that commercial real estate was overvalued then the investors would sell the private property and by the undervalued real estate asset stocks. This sounds good in theory but the private property market is often illiquid. It takes time to sell a property and there is also a rather high transaction cost that comes with a real estate transaction. However, the larger the difference between the valuations of the stock market and the private property market are the larger the benefits of moving capital from one market to the other. 20

21 As mentioned before, during the autumn of 2008 and the first quarter of 2009, the amount of transactions has decreased as to commercial real estate assets in Sweden. Transactions were lower because of higher risk premiums and larger difficulties to finance real estate acquisitions. There are fewer buyers and sellers on the market and they do seldom seem to agree about the price. This is leading to fewer transactions. However, on the stock market real estate asset shares are traded daily. The shares of large real estate companies on the Stockholm stock exchange are liquid assets compared to the private property market for commercial real estate. On the stock market buyers and sellers of liquid stocks reach prices on what they believe is the market value each day. At present these shares are traded at discount prices compared to the market values of the IFRS. At the present time the stock market values the properties of the real estate companies lower than the values that these companies use in their own quarterly reports, according to studies in Dagens Industri and Veckans Affärer. The IFRS values that are taken up in the companies reports should be the market value on these properties. The market values could be hard to estimate since properties are unique. The DCF valuation model is not an exact science and it becomes even harder when the transaction volume is low. However, a suspicion of biased valuations might get raised since all of the companies in this thesis have higher values on their properties than the share prices on the stock market show. It varies between the different companies how close they are to the valuations done by the stock market but all of the companies have higher values on their total property portfolios. According to Table 2.1, the valuations that the real estate asset companies most often use for the IFRS valuation is the income capitalization approach, which includes the DCF. The same model is the most accepted model for stock valuations. A lot of variables are uncertain in a DCF valuation and since different people most certainly will come to different values on a property one cannot come to the conclusion from this that the real estate companies are biased. As can also be seen in Table 2.1, three companies use internal valuations, six companies use external valuations and five companies use a combination of internal and external valuations on their properties. 21

22 Most investors would probably agree that the valuations of an external appraiser would be less biased compared to if a real estate company would use internal valuations of their properties. As Nordlund s studies show most companies let external appraisers do at least some of the valuations on their real estate assets. This decreases the bias that these companies for some reason might have. There could be numerous reasons for the real estate asset companies to keep the values high on their properties. For example the world economy has been facing a tough time during the recent financial crisis. It is said that there has been a credit crunch. This means that investors and banks have had larger difficulties to arrange finance of real estate acquisitions. If the banks would see that the asset values of these companies have decreased then they might make the real estate companies borrow at a higher interest rates or the banks might even force the banks to sell their property to ensure their debt. This thesis has not investigated whether the real estate companies have tried to keep the values high on their properties on purpose or not. The text that has been written about this subject has rather been a discussion. 22

23 5 The Real Estate Study At the beginning of this study the goal was to see how the seven real estate asset companies, traded on the Stockholm stock market, and how they have changed their market values on their real estate portfolios each quarter. It would be interesting to compare the market values to a property price index and to see whether the real estate companies always have been equally eager to value their properties according to the shifting market values. It would also be interesting to study how the seven quoted real estate companies are correlated to a property price index. Since I have not been able to find a property index for Sweden that is calculated each quarter this study has not been possible to do. However, a comparison with the SFI/IPD Swedish Property Index has been done yearly for 2005, 2006, 2007 and The SFI/IPD Swedish Property Index includes retail, offices, industrial, residential and other properties. The study has looked at the valuations of seven real estate asset companies traded on the Stockholm stock exchange. The market values and share price changes have been indexed each quarter since December 31 st 2004 to be able to do a graph to see how they follow each other. An index including all the seven studied real estate companies has also been created for both the total change in the market values and for the total change of the stock prices. This has been done to be able to see how the factors have changed since the end of 2004 until March 31 st The correlations have been calculated between the total changes of the market values and the total changes of the share prices each quarter. It can also be seen how the market values and the share prices are correlated with the quarterly changes in OMX S30. Through the study I hope to show whether and how the market values of the real estate companies property portfolios are correlated to their share prices. Of interest to the study has also been whether the main things that drive the stock prices are the market values of the properties or whether the real estate asset stocks are more correlated to a stock index (like the OMX S30). The results could show if these 23

24 companies shares are mostly affected by the macroeconomic changes or by the values in their portfolios. These factors have also been compared to the SFI/IPD Swedish Property Index. The correlations could not be calculated because the index has only been calculated once a year. A graph has been created to see the patterns between the SFI/IPD Swedish Property Index, the total index over the market values, the total index over the seven real estate companies shares and the NASDAQ OMX S30 index. This part of the study hopes to give answers to how these different asset indexes follow each other even although they cannot be statistically significant due to too few observations. 5.1 Data Input The data used in the study have been collected from a couple of different sources. The time horizon is between December 31 st 2004 and March 31 st Since 2005 all publicly traded real estate companies must, according to the standards of IFRS, value their assets according to the market values on the assets of the real estate portfolios. This is also the reason why the time period has started from the last of December All changes in market values should be included in the income statement. Since the studies main goal is to look at real estate asset values, the changes in market values of other assets have not been taken into consideration. The dates that have been used are based on company reports for 17 quarters from the last day of March, June, September and December each year. All data that have been used are based on capital growth. By definition it does not include dividends or income return. This is because the market values that the real estate companies present in their quarterly reports only show how much the values of their property portfolios have changed. This means that the companies show the capital growth or decrease of their real estate assets. The historical data on the stock prices have been collected from the homepage of the NASDAQ OMX where the data have been adjusted for factors like different share issues and splits. However, in some cases the adjustments have not been made and then the author has done the adjustments. The IFRS data have been found in the real estate asset companies financial reports. The data that have been collected from the 24

25 reports were the values on the property portfolios and how these values on their portfolios of real estate assets have changed since the last quarter. 17 reports have been reviewed for each of the seven real estate asset companies except for the company Wihlborg. For Wihlborg the study had to start two quarters later because the share prices were only available since May 2005 due to Wihlborg s initial public offering (IPO) on the NASDAQ OMX exchange that month. The OMX S30 has been used as a comparable index. It includes the 30 most traded companies on the Stockholm stock market. The SFI/IPD Swedish Property Index has been used too see how the property market in Sweden has developed. The SFI/IPD can calculate how the property market has developed once a year. The OMX S30 and the SFI/IPD Swedish Property Index are already weighted. However, the total index over the seven real estate asset companies shares and the total index of their market value developments have been weighted at each measurement date (each quarter). They have been weighted by the market values of their property portfolios divided by the total market values of all of the seven companies total portfolio values. To calculate the development of the market values of the real estate companies portfolios as well as the stock market index for the seven real estate companies the formula (S1-S0)/ S1 has been used. Here S1 is the market value or the stock price at the end of the chosen period and S0 is the market value or the stock price in the beginning of that period. This gives the capital growth or change during the period/quarter. Since real estate assets can be bought or sold during the period some special calculations had to be done in order not to affect the calculations. S1 was the market value of the property portfolio for quarter X. We cannot use S0 because it could include more or less property than is included in S1. To calculate a valid S0, S0 = (S1- Changes in the market values during the period). The changes in market value during the period are stated in the companies financial reports. The changes in market values include both estimated increases and decreases in the values of the property 25

26 portfolios. It would also include, if a property has been sold during the quarter, the difference between the estimated market value and the value it was sold for. Here is an example of the calculations of the capital growth for Hufvudstaden during the second quarter Changes in market values during the quarter were 570 million SEK and the market value of the total portfolio was 16934,9 mkr SEK the 30 th of June S1= 16934,9 and (16934,9 -S0)=570 S0=16364,9 (S1-S0)/ S1=3,48% 26

27 6 Results and Analyses from the Study The study shows that the total changes of the seven real estate asset companies are more correlated to the OMX S30 than to the total changes in their portfolios market values. See Table 6.1. If we can believe or accept that the market values are correct, according to the information from the real estate companies and the appraisers of their assets, then this means that the real estate companies share prices follow the stock market development closer than the value development of their own assets. The correlation between the changes in market values and the OMX S30 is even higher than the correlation between the market values and the real estate stocks. All of the correlations are positive. The smallest out of these three correlations is the correlation between the changes in the capital growth of the real estate shares and the changes of the market values of their assets. The results show that the real estate share prices act more as all share prices than as how their own portfolios of real estate assets develop. Table 6.1 Total Correlation Real Estate Shares OMX S30 Market Valued Portfolio 0,30 0,41 Real Estate Shares 0,58 The quarterly changes of the individual real estate companies stocks and the correlations to the market changes in their individual real estate portfolios, see Table 6.2, were between 0,29 to 0,38 for five of the seven companies. The company Kungsleden had a positive but smaller correlation of 0,19. For Wihlborgs the correlation was almost zero. All of the seven shares of the real estate companies had a larger correlation with the OMX S30 than with their own property portfolio. The results indicate that, in the long run, for an investor in real estate shares it is of more importance to estimate how the stock market index will develop than how the real estate companies different portfolios will develop. In Appendix 1 it is possible to see the capital growth of each real estate share and their property portfolio. 27

28 Table 6.2 Correlations with the individual shares The Real Estate Stock and their Market Value Hufvudstaden 0,36 0,56 Atrium Ljungberg 0,38 0,41 Castellum 0,29 0,40 Fabege 0,36 0,63 Wihlborgs -0,03 0,25 Kungsleden 0,19 0,41 Wallenstam 0,33 0,69 The Real Estate Stock and the OMX S30 The changes in the asset values were also controlled yearly to be able to compare the real estate share prices, their market values, the OMX S30 and the SFI/IPD Swedish Property Index. The changes can be seen in the Table 6.3 and the Graph 6.1. The quarterly capital growth, excluding the property price index, can be viewed in Appendix 2. The most interesting about this part of the study is that it seems as the SFI/IPD Swedish Property Index and the market values on the real estate companies portfolios follow each other closely. For 2005 and 2006 there is almost no difference in capital growth between the development of all the real estate shares total portfolios and the SFI/IPD Swedish Property Index. See Table 6.4. In 2007 the property index increased by 9,53 per cent and the real estate portfolios increased a bit less by 7,20 per cent. In 2008 both decreased in value but the real estate shares portfolios decreased by 3,71 per cent while the SFI/IPD Swedish Property Index decreased considerably by 7,87 per cent. The capital changes for 2008 show that the seven real estate companies in average did not decrease the values of their property portfolios as much as the property index. However, it is not possible to study each real estate company individually and to compare it to how the property index developed as each company s own different kind of property that might have changed more or less compared to the SFI/IPD Swedish Property Index. 28

29 Table 6.3 Index of the Capital growth since last December 2004 until last December of 2008 Figure 6.1 Capital Growth The SFI/IPD Swedish Property Index Market Value total Portfolio Real Estate Shares OMX S30 Last Dec ,00 100,00 100,00 100,00 Last Dec ,97 107,33 130,70 129,40 Last Dec ,25 118,12 177,89 154,64 Last Dec ,52 126,62 137,35 145,77 Last Dec ,33 121,93 101,56 89,28 Table 6.4 Capital Growth SFI/IPD Swedish Market Value Property Index total Portfolio ,97% 7,33% ,55% 10,05% ,53% 7,20% ,87% -3,71% In the Figure 6.1 it is also possible to see that the real estate share prices seem to follow the OMX S30 better than the market values of their real estate assets. This was also proven through the correlations earlier in the study. The index of the real estate shares and the OMX S30 has also been more volatile than the property price index and the market values of the shares. As can be seen by table 6.3, the property price index and the market values of the property portfolios did not increase as fast as the share prices of the real estate shares and the OMX S30. Neither did they decrease as much. For the period the data show that the best results are shown by the SFI/IPD Swedish Property Index and the market values of the real estate companies properties. From the end of 2004 until the end of 2008 the property market has had a 29

30 positive capital growth of around 20 per cent. These two only differ by 2,6 per cent over four years while the real estate shares and the OMX S30 have had a marginal positive capital return to a decrease of a bit more than 10 per cent. 30

31 7 Conclusions This master thesis has presented different valuation methods to value real estate shares and their portfolios. The same methods are used to estimate the market values of the real estate shares and their assets. Most often the income capitalization approach has been used that include the discounted cash flow and the direct capitalization method. Still the valuations differ, even though the same valuation methods have been used to value real estate shares and their property portfolios. Since the IFRS was put in practice from the 1 st of January 2005 until the last day of December 2008 both the market values of the seven investigated real estate companies portfolios and the SFI/IPD Swedish Property Index have shown a capital growth of about 20 per cent. While the real estate shares have shown a marginal capital growth of one and a half per cent and the OMS S30 has had a capital loss of almost 11 per cent. The study has shown evidence that the real estate companies shares have stronger correlations to the stock market index, the OMX S30, than to the estimated market values of their own portfolios. The real estate stocks act more as general stocks and do not follow the their asset portfolio values as well as other stocks. For an investor in real estate shares it is of greater interest how the stock market develops than how the estimated market value of a real estate company s property portfolio develops. 31

32 8 Bibliography Brealey R.A., Myers S.C., and Allen F. (2006) Corporate Finance (8 th ed.). New York, USA: McGraw-Hill Companies Inc. Geltner, D., & Miller, N. (2007). Commercial Real Estate, Analysis & Investment (2 nd ed.). Ohio, USA: Thomson Higher Education. Geraci, M. E. (Eds.). (2001). The Appraisal of Real Estate (12 th ed.). Illinois, USA: Appraisal Institute. Gorosch, D. for Jones Lang LaSalle (Inc.). (2009, January 12 th ). Färre fastighetstransaktioner under 2008 med regionala skillnader. International Financial Reporting Standard (IFRS). (2008). Summery of: IAS 40 Investment Property. Koller, T., Goedhart, M., Wessels, D. (2005). Valuation - Measuring and Managing the value of Companies ( 4 th ed.). New Jersey, USA: John Wiley & Sons. Lundstöm, S. (2008, November 6 th ). Prisfall på fastigheter slår mot börsbolag. Dagens industri, p. 4. Nordlund, B. (2008). Valuation and Performance in Property Companies According to IFRS. Stockholm, Sweden: Royal Institute of Technology (KTH). Schultz, P. (Eds.). (2009). 30 miljarder, Så mycket behöver börsens fastighetsbolag skrivas ner. Veckans Affärer nr 16, p 44. Wernerman, M. (Eds.). (2006). Internationell redovisningsstandard i Sverige, IFRS/ IAS. Stockholm, Sweden: Föreningen Auktoriserade Revisorer (FAR). 32

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