Commercial real estate investors, especially those who invest in real estate investment trusts (REIT) or private equity funds, are very interested in understanding the makeup of the real estate assets held by the entity. There are many ways that investors attempt to look at and analyze the income-producing assets held by the entity. There are also many metrics and calculations that investors can work through to help them understand the composition of the portfolio, the riskiness of the investments, and the strategies pursued by the investment management team running the fund or firm.
One of the metrics that investors often look at is called Gross Asset Value (“GAV”), and we are going to take a detailed look at what it is, how to calculate it, and how investors can use GAV as part of the research and due diligence process when deciding which investment strategy to pursue or whether to invest in a particular commercial property vehicle.
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Gross Asset Value Defined
Gross Asset Value is an accounting concept used mostly by real estate investment trusts and real estate private equity firms, like us, to help investors understand the nature of the balance sheet and to judge the riskiness associated with investing in the fund. In accounting there is a financial statement known as the balance sheet that investors use to understand the composition of the business or fund that they are thinking about investing in. The balance sheet helps investors understand how much cash the firm has, how much debt the firm carries, and how much property the firm owns. All of these are important for investors to understand, and for publicly traded vehicles, these accounts are scrutinized by professional financial analysts on a regular basis.
How to Calculate Gross Asset Value
Conceptually, GAV is the value of the firm’s tangible assets after adding back depreciation. The formula for calculating GAV is as follows:
Total Assets – Intangible Assets + Accumulated Depreciation = Gross Asset Value
Let’s take these accounting terms one-by-one to better understand the concept of GAV.
Total Assets is simply the aggregate accounting value of the assets that the fund or company owns. This includes things like cash, accounts receivable, and inventory. Of particular importance in commercial real estate investing, Total Assets also includes the carrying value of the physical real property as stated on the balance sheet.
Intangible Assets (vs. Tangible Assets)
In the accounting profession, assets are divided into two groups – Intangible Assets and Tangible Assets. Intangible assets are not physical, meaning they cannot be seen or touched like a multifamily property. Intangible assets tend to be things like goodwill, patents, copyrights, and trademarks. Tangible assets, on the other hand, are the things that often come to mind when thinking about business – cash, inventory, and physical real property.
Depreciation is an expense that is meant to help asset owners account for wear and tear to the asset through the normal course of use. Property, plant, and equipment, including real estate can all be depreciated because the thinking goes that they get “used up” over time. For example, a rental property that is lived in for many years will surely end up with some dents and dings, even if the property management company does a good job maintaining it.
Accumulated depreciation is simply the aggregate of all the annual depreciation expenses taken on a particular asset over the course of its life-to-date. For example, if a property owner takes depreciation on a straight line basis of $10,000 per year for ten years, then the accumulated depreciation amount after ten years will be $100,000.
Investors who calculate GAV for a fund or business often use it to compare against the debt that the entity carries. We’ll discuss this in more detail later. The important thing to know is that GAV is usually not looked at in isolation. Instead, it is compared against debt to arrive at a Debt-to-GAV Ratio, which is calculated as follows:
Debt / (Total Assets – Intangible Assets + Accumulated Depreciation) = Debt-to-GAV Ratio
A higher Debt-to-GAV Ratio implies that the fund carries more debt relative to the gross assets on the balance sheet. All else equal, a higher debt load means that the fund is riskier.
Gross Asset Value vs. Net Asset Value
We’ve just seen how to calculate Gross Asset Value and how to use it to compare against the debt held by the fund. Now let’s see how it compares to a concept known as Net Asset Value. Net Asset Value, or NAV, is a commonly used metric in fund accounting and typically appears in the fund’s financial statements. One thing to note about NAV is that it is usually expressed on a per share basis. The calculation for NAV is pretty straightforward:
(Total Assets – Total Liabilities) / Number of Shares Outstanding = Net Asset Value
Total Assets less Total Liabilities represents the net assets of the fund. Dividing by the numbers of shares outstanding gets us to the Net Asset Value of the fund.
Investors like to compare the NAV against the per share market price of a publicly traded fund, such as a REIT, to understand whether the shares might be trading at a discount or a premium to the NAV. Shares that trade at a discount represent a potential buying opportunity, although there might also be good reasons why the shares trade for less than the NAV. It’s up to the investor to do their due diligence to understand why this is the case.
Gross Asset Value in Commercial Real Estate Investing
Commercial real estate investors have many tools available to analyze deals and investment vehicles, and GAV is one of them. When deciding whether to invest or which property types to invest in, investors often use two types of metrics. One group of metrics focuses on the solvency or financial strength of the fund, while the other focuses on profitability.
Debt-to-GAV belongs to the group of metrics focused on solvency. The goal of these metrics is to help investors think about the risk of investing in the deal. They are concerned with how much debt the firm has relative to assets, book value, cash, etc. Firms that have high debt levels relative to the total value of the assets or cash runs the risk of not being able to repay the debt. In this scenario, the firm could find itself in liquidation or bankruptcy, which would lead to losses for investors. Analyzing solvency metrics can help investors to avoid investing in funds or deals that might have trouble repaying the lenders.
The other group of metrics that investors often use to analyze a fund or deal focuses on profitability and valuation. This group includes metrics such as rate of return, Gross Rent Multiplier, IRR, Net Operating Income (NOI), and Capitalization Rate, or Cap Rate for short. The metrics that focus on profitability are generally calculated by starting with gross rent and subtracting out operating expenses to get to NOI. From there the Cap Rate can be calculated. Metrics like IRR and NOI help investors to understand how profitable the deal might be, while cap rates can be compared to other deals or comparable properties that the investor already owns to judge whether the deal under consideration is a good value. Investors interested in publicly traded real estate securities such as REITs can compare metrics across different REITs to decide which ones to invest in. They can also compare against a broad index of real estate investment trusts such as the FTSE Nareit US Real Estate Index Series.
It’s important to know that investors aren’t the only ones looking at these metrics. Lenders and management teams also review metrics related to solvency, profitability, and valuation on a regular basis. In fact, we have an entire team that works on putting together pro forma financial statements and calculating profitability and valuation metrics to decide whether we should invest in a particular property. Management teams also keep a close eye on these ratios because they help the team to better manage the fund and investors’ money. Management is careful to keep solvency ratios within a safe range and strives to find deals with the best profitability and purchase price-to-rental income ratios.
Lenders also look at these metrics to decide whether or not to lend money to particular deals or funds. Lenders are very careful to think about whether a deal will be profitable and how likely the borrower is to pay back the amount borrowed. They are also concerned with the value of a property, and often require the buyer to pay for an appraisal to prove that the asset has a market value at least as high as what the buyer is offering to pay. While market conditions can change and cash flow can fluctuate due to low occupancy or other reasons that are outside the lender’s control, they still try to understand the ins-and-outs of the deal as well as trends in the broader real estate market.
Summary of Gross Asset Value in Commercial Real Estate
Investors who are interested in investing in real estate funds, whether private equity firms like us or publicly traded REITs, should understand how to calculate and use Gross Asset Value and Net Asset Value. It is important to understand that Gross Asset Value is an accounting concept that can be used to gauge the solvency of a fund. Net Asset Value can be used as a starting point for performing due diligence on publicly traded funds.
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