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octobre 13, 2023

Record Wide NAV discounts: Time to buy listed real estate?

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octobre 13, 2023

Record Wide NAV discounts: Time to buy listed real estate?


Insight Article

Record Wide NAV discounts: Time to buy listed real estate?

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octobre 13, 2023

 
 

Discounts in European listed real estate have rarely been this wide. Long-term investors should take note.

 
 

Investors have multiple choices when deciding to invest in real estate: They can buy buildings directly; they can give money to mutual funds that invest in buildings; or they can invest in listed stocks, via companies that develop, own and manage large commercial and residential real estate portfolios in closed-ended, publicly listed vehicles.

Despite challenges from higher interest rates, we note that public real estate stocks’ discounts to underlying independent appraisal values in Europe are close to historically wide levels, looking back over the last 30 years. We also show that, on average, for listed real estate, future returns increase the wider this discount is. This is particularly relevant on a five-year view and/or when discounts are very extreme.

As can be seen in Display 1, the discount to last-reported net asset value (NAV) of the larger European listed real estate companies has expanded to over 40% as at August 2023. These depressed levels are witnessed only occasionally, such as during the global financial crisis of 2008-2009 and the European Exchange Rate Mechanism (ERM) debacle in 1992. Other, less extreme lows, occurred when traditional real estate was out of favour during the tech stock boom of the early 2000s, and, of course, during the COVID-19 pandemic.

 
 
DISPLAY 1
 
Historical NAV valuation vs. next 5Y share price return
European listed real estate NAV valuation vs. next 5Y share price return (%)
 

Source: August 2023 Bloomberg, Datastream, Company data, Morgan Stanley

Data is provided for informational use only. Forecasts/estimates are based on current market conditions, subject to change, and may not necessarily come to pass. Past performance is no guarantee of future results.

 
 

These moments of significant uncertainty have offered highly beneficial entry points. Indeed, the earlier examples provided the bases for between 100%-200% (Display 2) cumulative returns over the following five years, as the listed markets typically priced in forward-looking direct real estate market valuation declines and more.

 
 
DISPLAY 2
 
NAV valuation and long-term share price return are correlated. At current discount levels, returns have been strong
Pan-Europe NAV valuation (horizontal axis) vs. next 5Y share price total return (vertical), monthly since 1990
 

Source: August 2023 Bloomberg, Datastream, Company data, Morgan Stanley

Data is provided for informational use only. Forecasts/estimates are based on current market conditions, subject to change, and may not necessarily come to pass. Past performance is no guarantee of future results.

 
 

At the discount witnessed at August 2023, historical data suggests that an almost 120% cumulative return over the next five years may be achievable, a compound annual growth rate (CAGR) of over 17% (Display 3).

 
 
DISPLAY 3
 
Listed European real estate index average share price return for different NAV valuation ranges
 

Source: Bloomberg, Datastream, Company data, Morgan Stanley.

Note on shading: green = above average returns, red = negative returns

The index performance is provided for illustrative purposes only and is not meant to depict the performance of a specific investment. Past performance is no guarantee of future results.

 
 

Between December 1989 and February 2023, there was a 100% hit rate of positive five-year total returns when the opening discount to NAV has been between 40% and 50%. While these are extremes, the trend is consistent at lower levels of discount. When the discount has been between 30% and 40%, the hit rate was still a high 82% over five years and 69% over one year (see Display 4).

 
 
DISPLAY 4
 
Listed European real estate hit ratio for different NAV valuation ranges
 

Source: Bloomberg, Datastream, Company data, Morgan Stanley.

*Note: hit ratio: % of positive monthly returns over total number of returns for each range

The index performance is provided for illustrative purposes only and is not meant to depict the performance of a specific investment. Past performance is no guarantee of future results.

 
 

There are some caveats. Normally, wide discounts signal sharp valuation declines in underlying real estate markets, that take some time to feed through, and current dislocation has largely been driven by higher interest rates. Some companies’ balance sheets may not survive this stress and require dilutive capital raisings. But time is a healer; and as our analysis shows, backtesting returns suggests attractive returns may be on offer, particularly for investors with a medium-term time horizon.

 
 

Risk Considerations

The value of investments may increase or decrease in response to economic and financial events (whether real, expected or perceived) in the Europe and global markets. The value of equity securities is sensitive to stock market volatility. Real Estate Risk: The risks associated with ownership of real estate and the real estate industry in general include fluctuations in the value of underlying property, defaults by borrowers or tenants, market saturation, decreases in market rents, interest rates, property taxes, increases in operating expenses and political or regulatory occurrences adversely affecting real estate. Real estate investment trusts (REITs) are subject to risks similar to those associated with the direct ownership of real estate, and they are sensitive to such factors as management skills and changes in tax laws. Concentration Risk: Concentration in a single region may make the portfolio more volatile than one that invests globally.

 
laurel.durkay
Head of Global Listed Real Assets
Global Listed Real Assets Team
 
simon.brown
Managing Director
Global Listed Real Assets Team
 
 
Christopher Fremantle
Christopher Fremantle, CFA
Executive Director,
European Listed Real Estate
 
 
 
 

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