Net asset value (NAV) in private real estate investing is the total value of an asset, minus any outstanding debt and the cost of any other fixed or planned capital expenses. It’s critical for real estate investors to understand this metric because asset prices drive current and future investor returns. An increase typically correlates with an increase in cash distributed to investors from the underlying asset.
Net asset value also demonstrates an investment firms’ ability to generate value for investors over time. In private real estate, it is calculated at the individual asset level and the fund level. It also can be provided to investors as a share value, depending on the investment structure. At Origin, we calculate the total value of each asset monthly, using up-to-date market and operational data.
Let’s walk through an example of how to calculate NAV for an asset that was purchased recently for $50 million. At the time of the acquisition, the asset’s total value is $50 million. To calculate NAV at time of acquisition, we subtract debt ($25 million) and planned capital and fixed expenses ($5 million) from $50 million. The NAV equals $20 million. See Chart 1 below for more detail.
Over months and years of ownership, NAV changes. Chart 2 below shows how it could look for an investment that has been improving operations after a year of ownership.
| At Acquisition | 1 Year Later | |
| Total Value | $50,000,000 | $52,000,000 |
| Less: Debt | ($25,000,000) | ($25,000,000) |
| Less: Capital & Fixed Expenses | ($5,000,000) | ($5,000,000) |
| Net Asset Value | $20,000,000 | $22,000,000 |
Because it’s a function of total asset value, any factors that change the valuation also change the net asset value. NAV changes largely fit into two categories: a change in net operating income (NOI) that is expected to continue over time, and changes in capital markets.
The Impact of Net Operating Income
NOI is all the revenue generated by a property, minus operating expenses. Property-level revenue changes with shifts in supply and demand. That impacts renters’ ability and willingness to pay. These changes can include factors from nearby properties offering rent concessions (implying low demand) to new nearby employment opportunities (implying higher demand). These changes affect short-term NOI but only affect NAV if the impact to the property’s income is perceived as sustained.
For example, let’s consider a well-located asset with a strong and diverse tenant base and Class A construction. It is currently operating below projected occupancy. Although occupancy for the next quarter will negatively impact income, the underlying strengths of the asset and its tenant base make it a stable long-term investment. If the market believes an asset has long-term viability, short-term changes in revenue and expenses will have minimal impact on NAV. You can see this reflected in the chart below labeled Asset X.
How Capital Market Changes Impact Net Asset Value
Capital markets, or the pricing and availability of capital, has the greatest impact on NAV. For most real estate investments, annual property income only accounts for 10% to 20% of total return. The remaining 80% to 90% is driven by the “capped NOI,” or residual property value. The cap rate acts as a multiplier on net operating income. So when supply or demand changes that affect entire asset classes or markets become permanent, these changes impact implied growth and exit cap rates. Therefore, they have the greatest impact on net asset values.
Asset Y, in the chart below, is a Class A multifamily property where 20% of the tenants work for a large nearby company. At acquisition, this property’s NAV was $20 million, and it was 100% occupied. However, what happens if, one year into ownership, the nearby company decides to relocate elsewhere? In contrast to the diverse tenant base of Asset X referenced above, Asset Y will likely lose many residents and therefore revenue. The loss of employment is permanent. So the market will perceive the negative impact on demand and revenue as sustained. Lower occupancy will become part of the “capped NOI” and have a serious impact on NAV. The chart below contrasts the effects of short-term NOI loss (Asset X) and long-term NOI loss (Asset Y) on net asset value.
A great example of the strength of cap rates is the West Loop neighborhood in Chicago. Over the last 10 years, this submarket has seen consistently increasing demand and has absorbed new supply at record rates. As a result of this perceived cash flow security and expected continued growth, cap rates have continued to compress. Therefore, regardless of fluctuations in NOI of the underlying assets, NAVs have continued to rise.
When Net Asset Value Changes
Unlike the stock market, private real estate net asset values do not react instantly to market events. Factors and trends that affect NAVs often take longer to impact supply and demand for the underlying asset. These adjustments to value often lag the public equities market by at least a quarter. Sometimes, fluctuations impacting the stock market may not affect real estate revenue at all. For example, in the fourth quarter of 2018, amid global trade and growth concerns, the public markets corrected and dropped more than 15%. But real estate values and growth projections remained unchanged. This resilience is why private real estate is recommended as a stabilizing component of portfolios for all types of investors.
For private real estate investors, understanding how an investment firm or partner calculates and reports on NAV means you can better understand projected returns. Responsible firms report this metric consistently and explain factors that caused any changes from prior reporting. Investors should beware of firms that never adjust NAVs or continue increasing them even when sustained market conditions indicate that they should have changed.
