News that Security Capital Group, the US listed property company, has launched a $2 billion war chest to invest in European property has caused a flutter in the industry. It is probably the most concrete sign that US investors, after experimenting with international diversification in stocks and bonds, are prepared to extend their activities to property, the third main asset class.
But it would be wrong to view this trend as an easy opportunity to sell a business at a tidy premium to net asset value.
As with migrant populations, migrant capital imports new traditions to the host country. One only need consider the rise of the corporate governance movement among institutional investors in Europe and the changes in the London Stock Exchange's dealing system to imagine the changes in store for the European property sector.
American money, if it flows to Europe in volume, will force changes in the way property, and property companies, are valued. And that, perhaps more than anything, will force changes in the ownership of European property.
Moreover, the traditional benchmarks by which "value" is measured in the UK seem crude when set against the complex mathematical constructions which US property operators use to gauge the merits of an acquisition. US analysts have discredited the merits of NAV measurements in favour of cash-flow based analyses.
Security Capital, for its part, says its acquisition strategy aims for high, sustainable growth in EBDADT (earnings before depreciation, amortisation and deferred taxes) and high rates of return on capital.
Of course, not all US property analysts eschew NAV-based analyses. But even those that do not are not generally prepared to use the NAV calculations agreed by chartered surveyors.
Green Street Partners, a Newport Beach, California-based REIT research company, uses calculations of NAV. But it adjusts these for a series of subjective variables, the most significant of which it terms "franchise value". "Franchise value pertains to the ability of a management team to create value over and above the current value of the existing portfolio," the partners write in their latest pricing model update.
Franchise value, the company says, explains the justification for REIT (property) shares to trade at a premium to NAV. "A REIT that does not have franchise value is hard pressed to argue that its shares should ever trade at a premium to NAV," Green Street says.
The implications of this judgment for the UK property sector, which typically trades at a discount to NAV, are worrisome. What will happen in the next downturn if US valuation methodology prevails?
While acknowledging that franchise value is hard to quantify, Green Street sets out several criteria. Moreover, Green Street says the company must have access to attractively priced capital debt and equity.
Calculating the cost of equity capital is the subject of considerable debate. In its simplist form, its calculation requires measuring the volatility of a company's share price relative to the market as a whole. Almost no UK property company has conducted the exercise.
"I have put this question to lots of companies and they don't know the answer," says Floris Van Dijkum, property company analyst at US-based investment bank Morgan Stanley.
Indeed, he says, most have no idea about how even to find the answer. However, he argues that one crude measure is to look at the inverse of a company's ratio of price/cash-flow per share. The higher the denominator under such a calculation, the cheaper the equity capital.
If Europe does begin importing US valuation techniques with US capital, it is difficult to imagine the sector will be recognisable in 10 years' time.
