Reported NAV ignores the fees and expenses the interest will pay until the fund winds up; a buyer has to price them in before reading the discount.
Reported NAV does not deduct the management fees and fund expenses the interest will pay for the rest of the fund's life, so a buyer must deduct their present value before reading the discount. On an illustrative €40.0 million real estate fund interest with four years to run, a 1.0 per cent fee and 0.3 per cent of expenses on NAV are worth €1.10 million today, and a bid at 88 per cent of NAV is a true discount of 9.50 per cent, not 12.
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 →
The interest is fictional. The fund is past its investment period and selling assets, so its NAV is expected to run down to nothing over four years in roughly equal steps as buildings are sold and proceeds distributed. Like many real estate funds in that phase, it charges its management fee on NAV. The buyer's target return, used as the discount rate, is 12 per cent.
| Input | Value |
|---|---|
| Reported NAV of the interest | €40.0m |
| Remaining life | 4 years |
| Management fee, on NAV | 1.0% |
| Fund operating expenses, on NAV | 0.3% |
| Buyer's discount rate | 12% |
| Bid, 88% of NAV | €35.20m |
The headline discount is 12.0 per cent. The question is what the buyer is actually paying for the assets underneath, once the costs that come with the wrapper are accounted for.
Project the fee base for each remaining year, apply the fee and expense rates, and discount each year's charge at the buyer's rate. Charges are paid through the year, so each is discounted from the middle of its year.
Charge(k) = opening NAV(k) × (fee + expenses)
PV = Σ Charge(k) / (1 + r)^(k − 0.5)
Fee-adjusted value = NAV − PV; true discount = 1 − price / fee-adjusted value
Excel: =SUMPRODUCT(C2:C5*(D2+E2),(1+$B$1)^-(A2:A5-0.5)) for the PV, where column C holds the opening NAV of each year.
| Year | Opening NAV | Management fee | Expenses | Total | Discount factor | Present value |
|---|---|---|---|---|---|---|
| 1 | 40.0 | 0.40 | 0.12 | 0.52 | 0.9449 | 0.49 |
| 2 | 30.0 | 0.30 | 0.09 | 0.39 | 0.8437 | 0.33 |
| 3 | 20.0 | 0.20 | 0.06 | 0.26 | 0.7533 | 0.20 |
| 4 | 10.0 | 0.10 | 0.03 | 0.13 | 0.6726 | 0.09 |
| Total | 1.30 | 1.10 |
The present value of what the interest still owes is €1.10 million, 2.76 per cent of NAV: €0.85 million of management fees and €0.25 million of expenses.
Deduct the €1.10 million from the €40.0 million and the interest is worth €38.90 million before any view on the properties. The bid of €35.20 million is 9.50 per cent below that figure. Of the 12.0 points of headline discount, 2.50 points, or 20.8 per cent of the headline, simply pay for the fund's remaining running costs. They are not a margin of safety, and they are not compensation for any risk in the buildings.
The reverse calculation is often more useful at the bidding stage. A buyer who wants a true 12 per cent discount to fee-adjusted value must bid €34.23 million, which is 85.6 per cent of reported NAV. A seller comparing that bid with others quoted as a percentage of NAV will see a deep discount; the buyer is in fact asking for the same 12 per cent, measured honestly.
| Remaining life | Fee 0.75% | Fee 1.00% | Fee 1.50% |
|---|---|---|---|
| 2 years | 10.72% | 10.41% | 9.78% |
| 4 years | 9.99% | 9.50% | 8.50% |
| 6 years | 9.36% | 8.71% | 7.37% |
The same 12 per cent headline can be anything from 10.72 to 7.37 per cent once fees are deducted. Remaining life matters as much as the fee rate, which is why an extension vote in the middle of a secondary process is a pricing event: two more years of fees on a slowly declining NAV remove close to a point of discount at a 1.0 per cent fee, and more than a point at 1.5 per cent. At six years and a 1.5 per cent fee the charges are worth €2.00 million.
Check the fee base in the limited partnership agreement. If the fee is charged on invested equity, here an assumed €46.0 million cost basis released as assets are sold, rather than on NAV, the present value rises to €1.23 million and the true discount falls to 9.21 per cent. A fund whose NAV sits below cost charges more than its NAV suggests.
Before comparing a real estate secondary bid with the market, deduct the present value of the fees and expenses the interest will still pay, and quote the discount to that fee-adjusted value. On a four-year tail at ordinary fee levels, a fifth of a 12 per cent headline discount is the fund's running costs. The full bridge from headline discount to the discount actually paid, with this deduction as one of its steps, is in the free workbook for the book, and the asset-level route to value is in how to price an LP interest on a bottom-up NAV.
No. NAV deducts fees accrued to the valuation date, not those the fund will charge until it winds up. In the illustrative interest, the fees and expenses still to come are worth EUR 1.10 million in present value, 2.76 per cent of the EUR 40.0 million NAV, and must be deducted separately by a secondary buyer.
The buyer's target return on the interest is the usual choice, because the fees reduce the cash flows that return is earned on. At 12 per cent the four-year charges of EUR 1.30 million are worth EUR 1.10 million today. Deducting the undiscounted figure instead gives a true discount of 9.04 per cent rather than 9.50.
It depends on the remaining life and the fee base. In the worked case 2.50 of the 12.0 points of headline discount pay for fees and expenses. With six years left and a 1.5 per cent fee, the same 88 per cent bid is a true discount of only 7.37 per cent.
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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