Reported NAV carries the fund's loans at par. A secondary buyer inheriting cheap fixed-rate debt is buying an asset the accounts do not show, but only for as long as the loan survives.
Value the loan as the market would today, by discounting its remaining interest and principal at the current rate for equivalent debt, and add the difference from par to NAV. An illustrative €200.0m loan fixed at 2.75 per cent with four years left is worth €182.37m at a 5.25 per cent market rate, so a €190.0m reported NAV becomes €207.63m, 9.28 per cent higher. The gain is real only for as long as the loan stays in place.
Worked in full in The Real Estate Secondaries Investor by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Real estate fund accounts usually carry the properties at appraised value and the borrowings at amortised cost. In a period when rates have risen, that asymmetry understates NAV for any fund that fixed its debt early. A secondary buyer pricing a discount to reported NAV is then measuring the discount from the wrong number. The adjustment is simple and it is one of the few in a secondary where the buyer's view is better informed than the accounts.
| Input | Value |
|---|---|
| Gross asset value | 400.0 |
| Fixed-rate loan, bullet, at par | 200.0 |
| Loan coupon | 2.75% |
| Years to maturity | 4 |
| Market rate for equivalent debt today | 5.25% |
| Other net liabilities | 10.0 |
| Reported NAV | 190.0 |
| Interest being bought | 10% |
The fund pays €5.50m of interest a year. The same loan taken out today would cost €10.50m. The €5.00m annual saving is an asset of the fund, and the reported NAV does not show it.
Fair value of debt = Σ (coupon × principal) ÷ (1 + r)t + principal ÷ (1 + r)n
Mark-to-market gain = principal − fair value of debt
Adjusted NAV = reported NAV + gain
r is today's rate for a loan of the same term, margin and security; n the years to maturity. In Excel: =-PV(5.25%, 4, 200*2.75%, 200) returns 182.37. The gain is the same as the present value of the €5.00m annual saving at 5.25 per cent: =-PV(5.25%, 4, 5), also 17.63.
The loan is worth 91.19 per cent of par, a gain of €17.63m to the borrower. Added to the reported €190.0m, NAV is €207.63m. The 10 per cent interest moves from €19.00m to €20.763m, an uplift of €1.763m.
| Measure | Fund | 10% interest |
|---|---|---|
| Reported NAV | 190.0 | 19.00 |
| Mark-to-market gain on debt | 17.63 | 1.763 |
| Adjusted NAV | 207.63 | 20.763 |
| Offer at 85% of reported NAV | 16.150 |
An offer at a 15.0 per cent discount to reported NAV is a 22.22 per cent discount to the adjusted figure. A seller who understands the debt can argue that the bid should be raised; a buyer who understands it knows how much room there is. Gearing is why the effect is large: at 50 per cent loan to value, a gain worth 4.41 per cent of gross assets is 9.28 per cent of the equity.
| Years remaining | Market 4.25% | Market 5.25% | Market 6.25% |
|---|---|---|---|
| 2 | 5.64 (3.0%) | 9.26 (4.9%) | 12.79 (6.7%) |
| 4 | 10.83 (5.7%) | 17.63 (9.3%) | 24.12 (12.7%) |
| 6 | 15.60 (8.2%) | 25.18 (13.3%) | 34.15 (18.0%) |
The term matters as much as the rate. That is where the secondary buyer's judgement comes in: the relevant term is not the loan's maturity but the period the fund will actually keep the loan. If the manager's business plan sells the assets in two years and the loan is not portable to a buyer, it will be repaid at par on sale and the gain falls to €9.26m, 4.88 per cent of NAV, or €0.926m on the interest. The two-year row of the table is then the right one, whatever the loan agreement says about maturity.
The adjustment also runs the other way. If the market rate is 2.00 per cent, the loan is worth more than par to the lender and NAV is overstated by €5.71m, 3.0 per cent. In that case read the prepayment clause: a yield maintenance or swap break cost will crystallise the loss on sale.
Three mistakes recur. The first is ignoring the debt altogether and taking the discount to reported NAV as the discount to value. The second is the opposite: marking the loan to maturity when the fund will sell before then and repay at par, which roughly doubles the gain in this case. The third is double counting. If the loan is floating rate and hedged with a swap, the swap is usually already carried at fair value in the NAV, and the debt adjustment would count the same saving twice. Check the balance sheet for a derivative asset before adding anything. The same applies when the figure quoted is an INREV NAV, whose adjustments already restate financing to fair value: confirm which NAV the discount is measured from.
Ask for the debt schedule, not the NAV statement. Coupon, margin, maturity, amortisation, prepayment terms and change of control clauses are what the adjustment needs, and they are rarely in the quarterly report. A loan that must be repaid on a transfer of the general partner's interest, for instance, may not survive a continuation vehicle.
Below-market fixed-rate debt is an asset worth the present value of the interest saving over the period the loan will really stay in place: €17.63m here to maturity, €9.26m to a sale in two years. Put it in the bridge from reported NAV to value before arguing about the discount. The free workbooks for the book price the in-place debt of a fund interest rebuilt from the property tape, and the GAV to NAV walk shows where the adjustment sits in the full bridge, alongside deferred tax and other liabilities.
Because most fund accounts carry borrowings at amortised cost, essentially par, while the properties are carried at fair value. When rates have risen since the loan was fixed, the loan is worth less than par to the borrower. On a €200.0m loan at 2.75 per cent with four years left, at 5.25 per cent the difference is €17.63m.
Yes, by the present value of the interest saving over the period the loan will actually remain in place. In the illustrative case that is €1.763m on a 10 per cent interest held to the loan's maturity, but only €0.926m if the assets are sold and the loan repaid at par in two years.
Then the adjustment runs the other way: the loan is worth more than par to the lender and the NAV is overstated. At a 2.00 per cent market rate the same loan reduces NAV by €5.71m, 3.0 per cent, and a prepayment or swap break cost may crystallise it on sale.
This article is one calculation from The Real Estate Secondaries Investor. 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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