Reverse Engineering Asset Values with Cap Rates
On the balance sheet of its most recent 10Q, American Campus Communities (ACC) listed the value of it’s real estate investments at $2.05B. This number closely reflects the amounts that ACC paid for its real estate holdings. That is NOT what the property is worth. I know that ACC paid too much. I know that because CEO Bill Bayless told me so - sort of.
Here is a brief dialogue between Analyst Karen Ford and CEO Bill Bayless from the transcript of the Q3 conference call at SeekingAlpha:
Karen Ford
And just a question on the V part of that LTV. What do you see as far as cap rates?
Bill Bayless, CEO
Right now, and some of the national brokers that we’ve talked to, the latest transaction we have closing is one in late September. It was at a major land grant institution, public institution about two miles from campus, class A product, that closed at an economic cap rate of 6.8%after contribution of management fee and CapEx.
So Bayless told us that cap rates are about 6.8% after contribution of management fee and CapEx. (I’m not exactly sure what the term “after contribution” means. Does he mean the Buyer’s perspective or the Sellers? I won’t speculate on his meaning and I will ignore that part of the equation. I think the amount is insignificant for my rough purposes.) He also spouted off about location and product… blah, blah, blah. While location is important, an ultra capitalist like me cares mostly about cash flow in this economy.
I don’t believe the 6.8% cap rate. Commercial real estate is not selling that low. Commercial real estate is not selling at all! I know a major industrial REIT is begging for someone to take 10% cap properties of their hands. Nobody is biting and nobody is lending. This is going to be the case for quite a while and ACC is going to get squeezed into Gambler’s Ruin even quicker.
I’m going to humor Bayless and use his 6.8% number for kicks but you can read Judy Weil’s artcile titled “Commercial Real Estate Offering 8%-9% Cap Rates, Anyone Interested?” at SeekingAlpha if you question my assertion with regard to cap rates. It is really just common sense that the cost of capital rises in a credit crunch… and make no mistake, we are in the Mother of All Credit Crunches.
Anyhow, we can figure out the true value of ACC’s property because we know what cap rates are like and what the properties cash flow at. Here is the basic formula we will use:
Asset Price = Net Operating Income (NOI) ÷ Capitalization Rate
In the case of ACC, if we figure out the NOI, we can solve for Asset Price. A common sense way to think of NOI is “… the number of dollars a property returns in a given year if the property were to be purchased for all cash and before consideration of income taxes or capital recovery.” (Click HERE for a good article). The formula for NOI is:
NOI = Gross Operating Income - Operating Expenses
Thus, for ACC’s Wholly Owned Properties, On-Campus Properties & Ground Leases for Q3:
NOI = $60,663,000 + $4,301,000 - $38,812,000 - $3,274,000 - $508,000 = $22,370,000
I can multiply this number by 4 to get annual NOI of $89,480,000. Now we can figure out the property value using NOI ÷ Bayless’ 6.8% Cap Rate such that:
ACC Real Estate Asset Value = $89,480,000 ÷ .068 = $1,315,882,300, or
ACC Real Estate Asset Value = $1.315B
This number is about $700M LESS than the $2.05B value shown for company’s real estate investments per the 10Q. If you subtract the value of all secured debt ($1,254,376,000), you can determine that ACC’s real estate equity is worth less than $100M.
If we use this new number to recalculate Total Assets, we find that Total Assets = $1,458,282,000. If you studied basic accounting you know that:
Total Assets = Total Liabilities + Stockholder’s Equity or
Stockholder’s Equity = Total Assets - Total Liabilities
Since we know that Total Liabilities = $1,355,333,000, we can calculate that:
Stockholder’s Equity = $1,458,282,000 - $1,355,333,000 = $102,949,000 or
Stockholder’s Equity = $103M or
$103M ÷ 42,305,883 shares = $2.44 per share
Per today’s closing price, the market cap for ACC is $923M or, by my calculations, about NINE TIMES REAL BOOK VALUE.
Now, I want you to remeber that I think that cap rates are realistically more like 10% + and they are only going up. We are going back to 1980’s style valuations and sooner or later we will have the second coming of the RTC! If we used a realistic cap rate, ACC would have a NEGATIVE valuation. This is how I know that ACC is headed towards Gambler’s Ruin! Who is going to refi them? Who is going to take more risk for the scheme?
Efficient Market Theory tells me that the stock ultimately headed in one direction. There might be detours on the way but the destination stays the same.
(You should know that the primary weakness in this calculation is the lack of consolidated data for ACC after the GMH Communities Trust merger. There is only one full quarter of data and there could be seasonal components to the data. I feel comfortable using these numbers because I know that ACC is weak and the economy is weak. Therefore, I do not expect a large upswing in NOI. Even if NOI does rise, I know that the cap rate figure I used is unrealistically low. If you don’t believe me, stop reading me, go buy ACC and don’t blame me when you lose your pants! Also, you should know that my analysis excluded development and management fee income. HOWEVER, I also excluded expenses incurred in those businesses and I excluded general and administrative expenses. If I included all of these components to evaluate the entire enterprise, we would get an even smaller number.)