Thursday, May 4, 2017

A New Look at Mall REIT Valuations

As most REIT practitioners know all too well, the mall sector has been hammered of late by fears of obsolescence engendered by the explosive growth of e-commerce causing the group as a whole to trade at a 30% or so discount to Street net asset value estimates. My explanation is that the estimates of value are way too high. How so?

At the present time the Street seems to be assuming that high quality malls are valued at a 4.5% cap rate, but in my opinion that doesn't take into account the increased capital spending required by mall owners to compete with the likes of Amazon. So instead of using a 4.5% cap rate lets use 5%. There is more though. Simply put some of the high quality malls are going to be degraded over time. My very rough estimate is that about 15% of the high quality malls will be re-rated over the next five years causing a cap rate increase to say 6% for those malls. Thus the weighted average cap rate should be 5.15%.

Now lets add another 50 basis points to allow for higher long term interest rates over the next few years yielding an adjusted cap rate of 5.65%. When you do this exercise you end up with a net asset value approximating current market prices. The arithmetic is below.

Net Operating Income   $45
Cap Rate Today                 4.5%
Firm Value                    $1,000
Debt @30%                       300
Equity Value                      700
Market Value                      490  (30% discount)

New Cap Rate                     5.65%
Firm Value                         $796
Debt                                     300
Pro forma Equity                  496
Market Value                        490

Thus the market might just have it right. You can play with my assumptions to your heart's content, but I think this is a reasonable analytical framework.

1 comment:

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