Real estate investors have been accused, perhaps justifiably, of having been slow to embrace the New Economy. However, having woken up to the possibilities, they cannot be said to lack enthusiasm. The plethora of business-to-business websites, last-mile infrastructure ventures and specialist technology ventures are becoming increasingly difficult to monitor.
But valuing them is an even trickier task. Real estate companies, after all, are collections of tangible assets. The current debate about valuation on both sides of the Atlantic centres around the best mechanism to measure assets. Some favour measuring net asset values after debt is calculated; others prefer some measure of cash flow or profitability generated by those assets. But all methods are a far cry from the approach taken by those charged with comparing value in the newly emerging technology businesses that real estate companies are entering.
Analysts in the US and the UK are starting to experiment with methods that will allow investors to better understand companies whose activities straddle real estate and technology. "These companies are creating intangible value," says Amy Young, real estate investment trust analyst at Deutsche Banc Alex Brown in New York. Moreover, Ms Young says, companies making forays into technology businesses are at real estate's cutting edge, and those most deserving of investors' capital. Industry analysts need to develop new methods to help investors compare strategies, risks and potential rewards of these efforts, she says.
In the UK, shares in Chelsfield surged in recent weeks, partly on two research reports from securities analysts that tried to assign a value to the company's new co-location telehousing business, Global Switch. Chelsfield owns a one-third stake in Global Switch, with an equivalent stake owned by Toronto-based Trizec-Hahn and a further third owned by the family of Andrew Ruhan, the company's founder. Broadly speaking, co-location is an arrangement where Internet data service providers lease space in data centre racks to customers, who, in turn, provide and manage their own network equipment. Analysts at Merrill Lynch - also brokers to Chelsfield - estimate the newly emerging Global Switch business adds from 125p to 150p per share to the value of Chelsfield, using a valuation methodology that looks at the fair value/sales multiples of similar operating companies that are not also in the real estate business.
Similarly, analysts at JP Morgan estimate that based only on the three telehousing centres already owned by Global Switch, the venture adds some 70p per share to Chelsfield's share price. Measuring the value in Chelsfield's Global Switch business is no idle exercise. Nigel Hugill, Global's managing director, says the business could eventually dwarf that of Chelsfield itself. Meanwhile, Trizec-Hahn recently announced it is abandoning its efforts to build a pan-European retail property business and will concentrate instead on its co-location activities. Thus, to misunderstand the value of Global Switch is to misunderstand the value of two quoted property companies.
Arguably, valuing Global Switch might be a more difficult process if there were no other companies in the same business. Although there are none with identical business plans and strategies, there are several that are sufficiently similar to provide a basis for comparison. TeleCity, a recently floated co-location provider, is also in that business, albeit one that doesn't own its properties and occupies generally smaller premises. In documents prepared for TeleCity's flotation, analyses of potential share price movements are made based on discounted cash flow models, although mention is made of price earnings to growth rates as another suitable basis for valuation. These models assume varying discount rates, starting at 35 per cent in the early years and discuss the impact of different discount rates.
However, it would be harder to make a strict comparison with the analysis provided on Global Switch by Merrill Lynch; for one thing, it relies on a more crude estimate of cash flow per square foot. Merrill Lynch does, however, attempt to look at fair value to sales ratios in attempting to calculate how Chelsfield's shares should trade in future. What is highlighted by efforts to compare TeleCity and Global Switch is not the differences between the businesses but the differences between the valuation methodology used for two broadly similar businesses and the potential for the market to misunderstand the value of either. Deutsche Banc Alex Brown has tried to grapple with a valuation methodology that will allow investors to understand the technology businesses of real estate companies through a new "blended" valuation model.
In a research report, analysts attempt to assign several different values to the shares of Simon Property Group's "clix n'mortar" businesses of which the largest is its 50 per cent stake in Merchant-Wired. Ms Young adds that Simon's internet activities make its business model closer to, say, Amazon.com, than that of a pure real estate company. In its analysis, Deutsche Banc values the real estate and technology businesses, each using multiples at which shares in companies in similar businesses trade.
The exercise adds $7.82 to Simon Property Group's projected share price, according to Ms Young. "This is just a first effort to ascribe a value to intangible assets," Ms Young says. "Calculating the value of the company just on the value of the assets does not recognise its worth."
