Opinion – From Grain to Grain: Find out how institutional investors value real estate

Most fail to evaluate real estate for acquisition. I commented yesterday on the risks in the usual metric for valuing real estate. The usual form gives the false feeling of being an effective and simple method. However, it hides a series of risks. I explain below how institutional investors carry out their real estate valuations.

To understand how these big investors evaluate, just go to the website of some of the real estate funds (FIIs) traded on the stock exchange. Annually, FIIs are required to hire an external company to appraise their properties.

Not all publish the appraisal report, but some examples of a report can be seen on the Vinci manager website. In this link, you will be able to find two examples of valuation reports for commercial buildings owned by FII VINO11.

Real estate is a high-value investment. In the portfolio of investors, they usually have a weight of 50% to 80% of the total portfolio. Therefore, this should be the investment you research and delve into before buying.

Imagine if in your stock portfolio, you had concentration in a specific company from 50% to 80% of the entire portfolio. Do you agree that this would be an action that you would have studied a lot and monitored periodically? The same should happen with your property or the one you intend to buy.

The example analysis above provides a fair value for the property, but ideally you pay a lower than fair value.

For fair value analysis, you must construct the cash flow for the next few years, for example, the next 10 years and then estimate a perpetual value based on this flow.

This system is similar to what analysts use to assess the fair value of companies.

The figure above illustrates the cash flow of one of the FII VINO11 properties.

As the figure illustrates, for the cash flow it is necessary to estimate the potential rent revenue, the real growth of this revenue, estimate possible vacancies and discounts, maintenance investments and general expenses.

You also need to estimate a discount rate to present the flows to present value. The basis of this discount rate is the interest rate of a government bond referenced to the IPCA. This rate needs to be increased by a risk premium. For example, 2% per annum. Thus, the discount rate could now be 8.0% per annum.

Let’s do a simple example.

Consider that you studied the demand for renting apartments in a region and found that a certain property could be rented for R$ 2,000.00 per month, that is R$ 24,000 per year.

If the property under study is for rent, you need to estimate a vacancy rate. For example, you can assume that every 5 years, the property goes 6 months without renting. This is similar to considering that in 1 month of the year the property would be empty.

Imagine a maintenance cost equivalent to BRL 150 per month, monthly condominium expenses exclusive to the landlord of BRL 50 and real estate administration costs equivalent monthly to BRL 200, the total costs would add up to BRL 400 per month or BRL 4 .8 thousand per year

Assume that the rent has a perpetual annual appreciation equivalent to 1% above inflation.

So, just divide the net cash flow value by the difference between the discount rate and this valuation rate. That is, the property should be purchased for a maximum of R$ 245.7 thousand (=17.2 thousand / (0.08 – 0.01)).

Most of the time, a property renting R$ 2,000 is bought for much more than that, as people do not consider the costs in the account. They often pay up to R$500,000 for this property.

Remember, R$ 500,000 invested in a government bond referenced to the IPCA at today’s rates, yield the equivalent of R$ 30,000 per year in interest that is corrected by the IPCA. Therefore, this title yields gains 74% greater than the apartment in the example.

Therefore, the income earned on the acquisition of property may be much lower than that of traditional fixed income investments such as government bonds or CDBs, if the purchase price is not adequately estimated.

Michael Viriato is an investment advisor and founding partner of Investor House

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