Are property valuations too conservative?

Jun 21, 2022

A big winner from the sale of the strata-held freehold Tanglin Shopping Centre for S$868 million that was announced early this year is City Developments (CDL), which owns 34.6 per cent of the share value and 60.2 per cent of the strata area of the property. CDL expects to book a significant gain from this sale of strata units, which the group held for investment since 1981.

Unlike many listed property groups, CDL holds its investment properties at cost less depreciation instead of mark-to-market valuation. CDL’s net asset value per share of S$9.28 as at end-Dec 2021 would be 69 per cent higher at S$15.70 if fair value gains on investment properties had been factored in.

Perhaps it is unsurprising that CDL will book a large gain on selling a property that is held at cost. What is surprising is that groups, which hold their properties at valuations provided by independent valuers, report healthy gains when selling their properties.

On Mar 31, 2022, Frasers Logistics & Commercial Trust (FLCT) completed the sale of Cross Street Exchange, which is a leasehold office and retail property in the Central Business District (CBD) here. A deal to sell this property for S$810.8 million, representing a 28 per cent premium to book value of S$632 million, was entered into on Jan 24, 2022. The property’s book value was based on valuation by CBRE as at Sep 30, 2021.

In January, CapitaLand Integrated Commercial trust announced the sale of JCube, which is a mall located in Jurong Gateway. The sale price of S$340 million was arrived at through a bidding process and comfortably exceeded the valuations by Savills and Colliers of S$278 million and S$280 million respectively as at Dec 31, 2021.

On May 25, 2022, ESR-Logos Reit announced that it would sell 3 Sanitarium Drive in Australia for A$55 million (S$53.4 million), which is at a premium of 18.5 per cent to the industrial property’s fair value as at May 19, 2022 of A$46.4 million.

Valuation methods

Valuers use methods such as the capitalisation method and the discounted cash flow method to value investment properties. In the capitalisation method, the estimated net income is divided by the capitalisation rate, which is meant to capture an appropriate investment yield.

In the discounted cash flow method, the projected net income stream over a period is discounted by an internal rate of return. Key assumptions include the rental growth rate and the target internal rate of return.

At times, valuers use the direct comparison method, where a property’s value is derived with reference to transacted prices of comparable properties.

Sure, any asset valuation is subject to assumptions. Different equity analysts may derive a range of values for a particular company. Various experts may come up with differing values for pieces of art or jewellery.

Different valuers may provide different values for a particular property, and such values may in turn differ from what a purchaser is willing to pay.

But is there something amiss when a deal is signed for Cross Street Exchange in January at a 28 per cent premium to a valuation that was done about 4 months ago?

A higher valuation of Cross Street Exchange as at-end Sep 2021 would have meant a higher net asset value for FLCT, and this in turn may affect the investment decisions of equity investors of the trust. Are other assets held by FLCT significantly undervalued?

However, there are reasons why investment properties in Singapore tend to be valued conservatively relative to actual transacted prices.

Investment properties are chunky assets that are fairly illiquid. Once an investment property is bought, it is typically held for at least a few years. A vendor of an investment property, which is not under pressure to ink a deal quickly, can choose to transact only when an attractive offer is received.

Prime commercial properties in Singapore are generally tightly held, including by financially strong owners who are not keen on selling their assets. Many owners of prime commercial properties here are long term investors, who focus on earning recurring income and long term capital appreciation.

Anecdotally, some owners of premier buildings here respond to unsolicited queries on whether a property is for sale by asking for an irresistible offer. In short, the supply of good grade commercial properties that is available for sale is limited.

Strong demand

On the demand side, Singapore is a global gateway city that attracts a wide range of investors. With a strong Singapore dollar, Singapore’s attractiveness as a business hub, political stability and good infrastructure, parties such as private funds, real estate investment trusts (Reits), insurance groups, sovereign funds and uber rich families are interested in buying prime commercial buildings here.

The Tanoto family’s Pacific Eagle Real Estate is the buyer of Tanglin Shopping Centre.

Last week, BT reported that US-based real estate investment manager AEW is buying Westgate Tower - a 20-storey office block near Jurong East MRT station - from Sun Venture Group for about S$675 million. Earlier this year, AEW sold two CBD office buildings - 55 Market Street to a unit of Kajima Corporation for S$287 million and Twenty Anson to KKR for S$598 million.

Benefits of conservative valuations

While conservative property valuations can potentially mislead equity investors, there are benefits to having conservative valuations in an uncertain world, particularly as risk of economic recession rises.

Reits need to adhere to the leverage limit, which is calculated based on total borrowings and deferred payments divided by the deposited property. Should an adverse event such as a lockdown or a recession put downward pressure on property values, a Reit may struggle to comply with the leverage limit if its investment properties had to be marked down in value substantially.

A commercial building owner, who took a bank loan based on a more conservative valuation of the said building, may have less trouble with refinancing the loan when market conditions are choppy.

Perhaps property valuers can be more bullish in their valuations. Still, a situation of listed groups selling assets at above valuation is on balance a healthy one. It means that the balance sheets of listed groups are generally conservative and demand for property is robust.