By: Kevin Morgan
Relative value in real estate is often ignored. Real Estate Relative Value, or RERV, pronounced with a strong and rolling “r”, is a critical piece in the puzzle of assessing the value of an asset. This is more than just reviewing the last comparable property that traded down the street of a subject asset or looking back at the peak of the market in 2008 and saying “we are getting this at a discount to where that trade occurred”. This also takes the common investment thesis that the discount to replacement cost that the opportunity provides is then used to substantiate how the deal makes sense because otherwise it would cost that much more to build. This is asking the question:
“Does this asset provide a risk adjusted return that is more favorable than we can get in a similarly priced or comparable investment”?
When utilizing RERV you can assess the risk adjusted return compared to where we otherwise can put money to work for our investors or similarly they can put their own money to work without us. Too often, and especially in real estate it seems, buyers do not consider the RERV and make price discovery or sale value decisions in a “vacuum”.
For example, if looking at a hotel investment opportunity that would produce an unlevered yield of 6.0% at a per acquisition price of $250,000/key, does that make sense and is this a fair price to compensate the risks of a single asset that maybe you are buying towards the end of a long real estate cycle? If you can go out and buy the equity in Host Hotels, a lodging REIT with similar hotel investments as the subject property, in a very liquid format with a dividend yield of 4.5% and at an implied per key price of $320,000 for the 90+ hotels the company owns, does the difference in the two relative values make sense?
Or similarly, if you can buy Host Hotels corporate debt maturing in 2021, a similar holding time frame as the underlying asset investment being considered, with an annual yield of 6.0% but no further upside but limited downside, does that single hotel equity investment still make sense?
Or maybe there is an office building next door to the hotel that is also on the market and offers a 4.0% yield and is 100% occupied for the next 10 years. How does this effect the relative risk / reward of the single hotel investment?
When we are looking at investment opportunities at JMA, given our unique and entrepreneurial investment mandate, there is a constant debate of if this produces a 17% levered internal rate of return over the hold period, for example, is that fair in the context of not only other investment opportunities currently in our own pipeline, but relative to other investments available in the general market. From there, it is getting granular in how we at JMA can create “alpha” to outperform those similar investment returns through asset management, re-positioning and capitalizing on a view of the general macro market where we are investing.