Four ways to put construction in progress and land into net asset value, worked on one illustrative pipeline, and why the choice moves NAV more than the cap rate on the stabilised portfolio suggests.
Carry each project at cost plus the share of its expected development profit already earned, measured by the proportion of cost spent, and recognise any expected loss in full. On an illustrative pipeline with 315.0 ($ millions) spent and 435.0 to go, that gives 372.3, or $3.72 a share, against $3.15 at cost and $4.51 if every project is taken at stabilised value less cost to complete. The difference between the last two is mostly profit on buildings that do not yet exist.
Worked in full in REIT Analysis and Valuation by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Net asset value for a REIT capitalises the NOI of the operating portfolio. Construction in progress and land produce no NOI yet, so they are added separately, and the implied cap rate removes them for the same reason. How they are added is a choice, and for a REIT with a large pipeline the choice can move NAV per share by more than a 25 basis point change in the cap rate on the stabilised assets.
| Project | Cost to date | Cost to complete | Stabilised NOI | Months to stabilise |
|---|---|---|---|---|
| Logistics park, 85% built | 170.0 | 30.0 | 13.00 | 9 |
| Lab building, 40% built | 120.0 | 180.0 | 19.50 | 24 |
| Entitled land, not started | 25.0 | 225.0 | 16.25 | 42 |
| Pipeline | 315.0 | 435.0 | 48.75 |
Yield on cost = stabilised NOI ÷ total cost = 48.75 ÷ 750.0 = 6.50%
Value on completion = stabilised NOI ÷ cap rate = 48.75 ÷ 5.50% = 886.4
Development profit = 886.4 − 750.0 = 136.4, an 18.2% margin on cost, from a 100 bp development spread
At cost = cost to date = 315.0
Percentage of completion = cost to date + profit × (cost to date ÷ total cost)
Discounted = value on completion discounted at 8.0% from stabilisation − cost to complete discounted from the middle of the build
Full = value on completion − cost to complete
In Excel, per project: =ToDate+MAX(NOI/Cap-ToDate-ToGo,0)*ToDate/(ToDate+ToGo)+MIN(NOI/Cap-ToDate-ToGo,0) recognises profit by completion and any loss in full.
| Project | Value on completion | Profit | % complete | At cost | % of completion | Discounted | Full |
|---|---|---|---|---|---|---|---|
| Logistics park | 236.4 | 36.4 | 85% | 170.0 | 200.9 | 193.7 | 206.4 |
| Lab building | 354.5 | 54.5 | 40% | 120.0 | 141.8 | 133.0 | 174.5 |
| Entitled land | 295.5 | 45.5 | 10% | 25.0 | 29.5 | 20.0 | 70.5 |
| Pipeline | 886.4 | 136.4 | 315.0 | 372.3 | 346.7 | 451.4 | |
| Per share | $3.15 | $3.72 | $3.47 | $4.51 |
The full method adds $1.36 a share over cost, 43.3 per cent of the pipeline's book value, by booking every dollar of profit today. A third of that, 45.5, comes from land on which nothing has been built, with 225.0 still to spend and 42 months to stabilisation. The percentage of completion method books 4.5 on the same land. The discounted method is lower still, because at an 8.0 per cent rate for development risk the logistics park's 36.4 of profit is worth only 23.7 net of time, and the land comes out below its cost: 20.0 against 25.0 spent.
| Cap rate | Total profit | % of completion | Per share | Full | Per share |
|---|---|---|---|---|---|
| 5.00% | 225.0 | 409.5 | $4.09 | 540.0 | $5.40 |
| 5.50% | 136.4 | 372.3 | $3.72 | 451.4 | $4.51 |
| 6.00% | 62.5 | 341.2 | $3.41 | 377.5 | $3.78 |
| 6.50% | 0.0 | 315.0 | $3.15 | 315.0 | $3.15 |
| 7.00% | −53.6 | 261.4 | $2.61 | 261.4 | $2.61 |
Profit is a narrow margin on a large number, so it is highly geared to the cap rate. Fifty basis points either way of 5.50 per cent moves the full-method pipeline value by 73.9 to 88.6, and the profit by more than half. At a cap rate equal to the 6.50 per cent yield on cost there is no development profit at all and every method converges on cost. Above it, the loss is recognised in full rather than by completion, which is why the 7.00 per cent row shows 261.4 under both methods.
Check the yield on cost against the cap rate the same REIT uses for its operating portfolio. A pipeline marked at a 6.50 per cent yield on cost and a 5.50 per cent exit, inside a NAV that capitalises the existing buildings at 6.00, is assuming its new buildings will be worth more per dollar of NOI than its old ones.
The common mistake is to take a company's disclosed "estimated value on completion" or its expected stabilised yield, capitalise the NOI, deduct the remaining spend, and add the result to NAV. That is the full method: it treats land as finished buildings, ignores two to four years of construction and leasing risk, and counts profit the shareholders have not yet earned. It also double counts if the REIT trades on a multiple that already prices its development platform. Recognise profit as it is earned, and mark land at cost or market value, as in the NAV build of how to calculate a REIT's NAV per share.
Value construction in progress at cost plus profit earned to date: here $3.72 a share against $4.51 on full value, or $3.68 with the land held strictly at cost. Then test the profit against the cap rate, because a 100 basis point development spread is the whole of it. The NAV build with the development line, the cost of capital and the development spread for the book's worked REIT are in the free workbook for this case.
Cost is the floor, not the answer: it ignores profit already earned on nearly finished projects. In the illustrative pipeline, cost is 315.0 ($ millions), while recognising profit in proportion to the cost spent gives 372.3, $0.57 a share more on 100 million shares.
More than the cap rate the finished asset would sell at, with a margin for risk. At a 6.50 per cent yield on cost and a 5.50 per cent cap rate, the 100 basis point spread creates 136.4 of profit on 750 of cost; at a 6.50 per cent cap rate the profit is nil, and at 7.00 per cent it is a loss of 53.6.
At cost or market value, with little or no development profit until construction starts. On the full method the illustrative entitled land contributes 45.5 of profit, 33 per cent of the pipeline's total uplift, for a project that has 225.0 still to spend and 42 months to stabilisation.
This article is one calculation from REIT Analysis and Valuation. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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