Half-year asset valuation of EfTEN real estate funds
According to the internal rules of procedure of EfTEN’s four real estate funds, at the end of every half-year we adjust the balance sheet values of our real estate portfolio investments to current market prices. For fairer results and greater transparency, we do not perform the valuation ourselves but outsource it to an independent valuation company, and EfTEN’s partner in this respect is Colliers International. This is one of the few internationally known real estate advisory companies, which operates in all Baltic countries, like EfTEN. Colliers has conducted our real estate valuations for the past 8 years, and it is important to point out that the company analyses our entire portfolio. This means we do not hold a ‘tender’ among different property valuation firms, in order to find the currently most optimistic valuation for a specific building and thus inflate our funds’ equity on paper, but prefer one valuation partner to perform every six months valuations of all the 48 buildings we manage.
The key concept in real estate valuation is that of ‘assessment’ is essentially an opinion. Certainly, it is a substantiated judgement and the best reflection of the current situation on the basis of broad market experience, but it is still an opinion. Real estate valuation is a licenced activity, and one cannot become a valuer without being properly certified; in addition, certain work experience is required. Naturally, the actual value of a property will be determined at the notary’s office, which is to say, in course of an actual sale and purchase transaction. For example, EfTEN’s first fund has sold over the 12 years 12 properties from its portfolio, 10 of which were sold at a higher value than the book value at the moment of the sale transaction. Two of the buildings were sold at exactly the same value as the book value at the moment of the transaction. So, it can be said a lot depends on the timing of the specific sale transaction, the market segment at the moment and on whether it is the sellers’ or buyers’ market.
The coronavirus pandemic wreaked havoc everywhere, and, essentially, a market of commercial real estate investments in the Baltics does not exist at the moment. Consequently, valuation companies have difficulty assessing the actual market price of one or another property. Market participants have learned about a number of transactions that did not happen due to the general uncertainty brought about by the coronavirus crisis. Time will show whether these deals will be concluded or not. Still, one transaction was successfully completed, when East Capital acquired the building of SEB headquarters in Tallinn with a net yield of approximately 6%. In other words, the valuers are lacking benchmarks and reference transactions for getting fair values of the assets in EfTEN’s portfolio, as at the end of June 2020. This is why Colliers have noted that the acceptable valuation range is currently larger than it would normally be. Colliers assesses the difference at +/- 5% compared to a normal market situation. As our third fund’s total amount of investments in real estate constitutes 130 million euros, and the loan amount does not change because of the market value, the 5% accuracy class will affect our equity capital with about double leverage , i.e., by +/- 10%.
It is clear that the coronavirus crisis has not increased real estate prices. They are unlikely to have remained the same, but it is virtually impossible to say at the moment how large the reduction in real estate prices has been. Looking at stock exchanges, we can see how quickly the prices of assets on liquid markets have recovered in comparison to the low point during the crisis. The reason lies not in outstanding economic results of companies, but a massive monetary policy on the part of central banks and governments for the stimulation of demand and prevention of the economic cycle from freezing. Government leaders all over the world have been rushed with announcements about unprecedented stimulation packages, comparable to the period after World War II in terms of the percentage of the GDP, by the example of the US federal budget deficit. This avalanche of money will clearly reach real economy with a delay and only partially, because a major part of the new money supply will accumulate in asset prices, namely, on stock exchanges, in real estate, commodities, and not in real economy as hoped for. This trend will undoubtedly also affect the long-term value of the world’s largest asset class, which is real estate. In other words, it is clear that the coronavirus crisis will have short-term repercussions for real estate prices, but at the same time and in the long term, the tide of state-funded stimulation will help keep all boats afloat, and real estate is not an exception and, all things considered, would be one of the biggest winners.
As at the moment of the half-year valuation, the net yield on the real estate investments by our listed EfTEN Real Estate Fund III AS equals to 7.45%. To put it in a simple way, net yield means the annual cash flow the property owner will have, after deduction of all the building maintenance costs, which is divided by the fair market value of the assets. As for making investments, we also use a bank loan at the current interest rate of about 2.3% in the amount of approximately 50% of the value of assets, and thanks to leverage the return on equity will increase to over 10%, and, most likely, even to a range of 12–15% per annum. This is a very decent result, which reflects the normally expected level of real estate funds’ return on capital.
It has been said time and again that we are all waiting for the autumn to see what would be the long-term effects of the virus pandemic and the resulting restrictive measures on economy. If the second wave of the virus is flatter than feared, and governments have had enough time to prepare for it, it can be expected that business as usual in the real estate sector would recover in the second half of the year. Also temporary decrease in rental fees, which has been one of the main reasons in the current lower valuation, will have a temporary effect. This, again, would once again result in an increase in real estate prices.
What the total demand for commercial spaces will be like in the world after the coronavirus pandemic is a separate matter. It is logical to assume that the decline of economic activity would hamper the demand for new commercial spaces. Which is to say, launching new commercial buildings on the market is likely to suffer a blow, and competition among the existing ones will become fiercer. Although it’s a bit too much to assume that there will be no demand for office spaces (because everyone will be working from home) or retail spaces (because all shopping will be done online), one should however remain conservative. It is namely the conservative investment strategy and the valuation practice of our assets that we have always adhered to at EfTEN. And I can assure you we intend to keep doing so.
CEO of EfTEN Capital