NAV discount determinants and confidence in property appraisal

What is it about?

This paper analyzes the NAV discount of European REITs listed in key European markets, namely France, the Netherlands and the United Kingdom between 2003 and 2014, considering elements of both “rational” and “noise trader” approaches. The analysis examines the hypothesis that discounts (premiums) are the result of leverage, size, liquidity, risk, performance, investment activity and sentiment. The regressions are initially run against the traditional NAV discount, subsequently using the Unlevered NAV discount measure introduced by Morri, et al. (2005) in order to clean out the bias generated by the level of Leverage. The NAV discount is then adjusted for investor sentiment (appraisal reduction), and a new model is developed with the aim of better identifying firm-specific factors, factorizing any possible distortions induced by sentiment into the dependent variable. One of the main conclusions is that REITs listed in different markets behave differently. In particular, the relationship between leverage and the traditional NAV discount is positive for REITs based in England and France, but negative for Netherlands-based REITs. When the discount is adjusted in order to remove the bias resulting from the level of debt, the relationship between leverage and the unlevered discount becomes less pronounced in all cases. Higher liquidity commands lower discounts for French REITs, while Dutch and British REITs, which trade in markets characterized by a higher number of average daily transactions, do not seem to feature discounts resulting from liquidity. For all three samples, operational risk and performance are significant in explaining the NAV discount, the former having a positive relationship with the discount, and the latter a negative one. When measured using the average sector discount, sentiment has a profound effect on the discount, accounting alone for 10% to 15% of the explanatory power of the model. Sentiment adjusted regressions are introduced to develop a model that is not influenced by this bias, and they describe a partially different picture, strengthening some factors and weakening the influence of others, and point to even more differences between different markets. Changes of behaviour between growth periods and during crises are also investigated. A further analysis of the NAV discount during upswing and downturn phrases enables to conclude that, while fundamental factors are more relevant and stable when the market is growing, price fluctuations during periods of recession are heavily influenced by market sentiment, and fundamentals do not describe the dynamics of the NAV discount in a satisfactory way.

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Why is it important?

It helps undestanding NAV discount determinants in EU market.