Investors routinely speak about the value of an asset as though it were a single number. It is not. The same building will carry several defensible values at the same moment, depending on who is asking and why, and understanding which number is being quoted is the difference between an informed decision and a misunderstanding dressed as one.
The three approaches, and when each governs
Valuation of a real asset generally proceeds by one of three routes. The comparable approach looks at what similar assets have sold for, and governs where the market is liquid and the asset is ordinary: apartments, small commercial units, standard warehouses. The income approach capitalises the net income the asset produces, and governs where the asset is held for yield: offices, logistics, multi-let residential. The cost approach asks what it would cost to replace the asset, and governs where nothing comparable trades and there is no reliable income, which in practice means specialised buildings and certain development situations.
A competent valuation will use more than one and reconcile them. A valuation that uses one and asserts the answer is a valuation to read carefully.
Market value is not the only value
European valuation practice distinguishes market value, the price a willing buyer and seller would agree, from other bases used for specific purposes. Value for mortgage lending purposes is deliberately more conservative, stripping out speculative elements and short-term market enthusiasm, because it exists to protect a lender over the life of a loan. Investment value is the value to a specific investor given their particular position, which can legitimately exceed market value.
A borrower who quotes market value to a lender expecting the lender to lend against it has misunderstood which number the lender is using. We deal with the lending consequence in our note on private debt secured on Spanish real estate.
An asset does not have a value. It has several, each answering a different question, and the argument is usually about which question is being asked.
What actually moves the number
For an income-producing asset the yield applied to the income does more to the valuation than almost anything else, and the yield is a judgement about risk: the covenant strength of the tenants, the length of the leases, the liquidity of the location, the capital expenditure the building will demand. A tenant with ten years unexpired and a strong balance sheet produces a different yield from a tenant with two years and a weak one, on the same rent.
Which means the operational work of asset management, extending leases, improving tenants, controlling capital expenditure, is not administration. It is the thing that moves the yield, and the yield is the value. This is the discipline we describe in our note on what an operating-partner mandate actually involves.
The strategy determines which value to chase
A core investor is buying an income stream and cares most about its durability. A value-add investor is buying the gap between what the asset produces today and what it could produce after work, and cares most about whether that gap is real and achievable. The valuation questions differ accordingly, and we set the strategies out in our note on core, core-plus and value-add in European real estate.
Reading a valuation critically
The useful questions when a valuation lands are consistent. What basis of value is it, and who is it addressed to. What comparables were used, and are they genuinely comparable in location, condition and timing. What yield was applied and what justifies it. What assumptions were made about capital expenditure, vacancy and letting periods, and are those assumptions ones the market would accept. And what special assumptions, if any, does the valuation rest on, since a valuation subject to a special assumption is a conditional statement rather than an unconditional one.
An investor who can ask those five questions is not dependent on the valuer’s conclusion. An investor who cannot is buying the number rather than the analysis.
Montclare manages and structures European real assets for institutional and private investors, from acquisition through to exit. Our services are set out on our services page.
This article is informational and does not constitute investment, tax or legal advice. Asset management and investment advice are regulated activities and the treatment of any transaction depends on its facts. Each engagement is subject to scope and applicable regulation.