How to Value Property by SG, The Value Edge
As fundamental investors, the art of valuation is our main weapon against the irrationality. In a land-scarce country like Singapore, property holdings are a common and significant source of value, even for companies not in the property business. Today, I would like to share my method of valuing properties. It may not be the most accurate, but as always, the objective here is to broaden perspectives.
I categorise property valuation under two categories – Earnings and Asset Value. Earnings is derived mainly from rental income while Asset Value refers to the fair value of the land and building if it were sold. At a deeper level, the two are actually converge as you can convert earnings into a pseudo-Asset Value using a DCF or rental yield model.
Before we jump into the nitty gritty of the two categories, there are a few key terms that you should know when it comes to property valuation.
Gross Floor Area (GFA)
When you buy a plot of land, you do not just simply build a one-storey house. By building more than one-storey, you are able to increase the gross floor area even though your land area remains unchanged.
Gross Floor Area ratio (GFA Ratio)
The GFA ratio is simply the ratio of your gross floor area to your land area. The higher the ratio, the greater number of floors you can build for a unit area. Everything held constant, a plot of land with a higher GFA ratio will be worth more than one with a lower GFA ratio. This GFA ratio is set by URA.
Net Lettable Area (NLA)
A building will not be able to rent 100% of its GFA. Out of the entire GFA, some of it would have to be used for common areas like lifts, corridors, toilets etc. Such areas do not earn rental income for landlords. Therefore, adjustments would have to be made to the GFA to obtain the NLA for which rental income would be charged. While the exact adjustment would be hard to determine, I usually apply a discount of about 20% to the GFA, after all, every owner would want to maximise the NLA so I think 20% is a sufficiently conservative amount.
Now we move on to the actual valuation in terms of Earnings and Asset Value which are actually very similar.
1. Determine land area
If it is a new acquisition, this will be disclosed in the announcements. Otherwise, you can find the information in the notes of Annual Reports.
2. Find the gross floor area
To do this, you first need to know the GFA area. This information can be obtained from URA’s Master Plan. Simply search for the address of the land and it will zoom in and display its corresponding GFA ratio. Once you have that figure its simple arithmetic to find the GFA. Make the necessary adjustments and you would have your NLA.
3. Average rental/price per unit area
This is usually the most challenging and the most critical part of the research. My general principle is to base it on recent transactions in the vicinity (the nearer the better). To find such information, you can use sites like propertyguru or commercialguru which property owners use to advertise their properties for sale or rent. While this isn’t exactly a recent transaction, it does give a flavour to what the market rate is for properties in the area. However, one disadvantage is that new property launches may not use such platforms for their marketing so you may not be able to find timely information in such scenarios. There are ways around this; if you are loaded (the subscription fee isn’t cheap) you can subscribe to URA’s REALIS where you will be able to find records of all recent transactions. Squarefoot Research is a much cheaper alternative – the free account provides sufficient information about transaction prices and there’s always the option of a paid subscription. I’m not paid to advertise for them by the way.
Depending on the situation, choose the appropriate valuation method based either on rental or sale price, multiply it by the net lettable area and you will arrive at your final figure. The method of valuation depends largely on management intention – do they intend to dispose of the property to unlock shareholder value or to retain it as a source of income? In scenario A, if the company owns the land and is sitting on the premises as an office or factory space, asset value would be the way to go. In scenario B, if it is redeveloping a land and intend to rent the units out as an additional source of income, I would go with earnings.
It seems pretty straightforward at this point but it won’t always be that easy. When it comes to Asset Value, the valuation described above is based on Sale Price x Net Lettable Area. There are times where the sale price is for per land area rather than per net lettable area depending on where you get the information from, therefore caution would have to be exercised in multiplying by the correct denominator. In any case, I think using either would be fine as value from building (net lettable area) and land (land area) are mutually exclusive since they are just linked by the GFA ratio (for a large part).
I would like to end with a warning against converting asset value to earnings for example, in the case where a company (like a property developer) develops a condo and sells the units. Upon conversion, asset value becomes merely a top line in your income statement, so remember to account for margins.