The rule that a company trading below net asset value cannot issue equity to buy assets is false over a measurable band of discount, and the band takes one division to find.
Yes. A listed property company keeps acquiring accretively down to a 6.2 per cent discount to net asset value, and down to an 11.6 per cent discount once the acquisition is funded at its target mix of debt and equity. The break-even share price on the worked company is $40.32 all-equity, against net asset value of $42.97. The frontier is not zero discount; it is six points inside it, and further still with debt in the mix.
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 →
A listed property company cannot fund growth from retained earnings, because the distribution requirement that buys its tax exemption takes the cash out. Growth is funded by issuing capital, and the price at which equity can be issued is set by the market. The share price is therefore an input to the business, not a scoreboard on it.
The cost of that equity is the adjusted funds from operations yield — adjusted funds from operations per share divided by the share price. It is what a new shareholder receives in cash earnings per dollar invested, and therefore what existing shareholders give up when a share is issued. On the worked company, adjusted funds from operations of $2.117 per share against a price of $34.50 gives a cost of equity of 6.14 per cent. Accretion is the transaction cap rate less that yield.
| Case | Share price | Discount to NAV | Cost of equity | Accretion vs 5.25% |
|---|---|---|---|---|
| Market price today | $34.50 | 19.7% | 6.14% | −89 bps |
| At net asset value | $42.97 | 0.0% | 4.93% | +32 bps |
| Above net asset value | $50.00 | −16.4% | 4.23% | +102 bps |
Read the middle row again. At exactly zero discount, accretion is not zero. It is plus 32 basis points. The company is already acquiring accretively at the price that is supposed to be the dividing line, so the dividing line is somewhere below it. Finding it takes one division: set the cost of equity equal to the cap rate. Adjusted funds from operations per share divided by the cap rate is $2.117 over 5.25 per cent, or $40.32. That is a 6.2 per cent discount to net asset value.
Nor is the all-equity comparison the right one. The test that survives is whether the transaction raises adjusted funds from operations per share after funding it with the company’s actual target mix of debt and equity. Fund the same acquisition thirty per cent with debt at 4.5 per cent and the break-even price falls again.
| Funding assumption | Break-even price | Discount where acquisitions turn dilutive |
|---|---|---|
| All-equity, as the table above is struck | $40.32 | 6.2% |
| Blended at the target mix, as the method prescribes | $38.00 | 11.6% |
So “cannot” is false over a band of discount running from zero to somewhere between six and twelve points. On this company that band is $4.97 per share. On 180.0 million shares it is about $895 million of market value — and a company sitting inside it is being told to stop acquiring at the exact moment its own arithmetic says it may continue.
The explanation is not subtle. Net asset value capitalises the buildings. The adjusted funds from operations yield is struck after overhead, after interest and after recurring capital expenditure. Those deductions are the wedge, and the largest of them is measurable directly.
General and administrative expense of 42.0, capitalised at the 5.25 per cent cap rate, is worth 800 — $4.44 per share, or 10.3 per cent of net asset value. The gap between net asset value and the all-equity frontier is $2.65 per share. Capitalised overhead alone is nearly twice that.
The frontier does not sit at net asset value. It sits at net asset value less the capitalised value of everything standing between the buildings and the shareholder. A company carrying heavier overhead has a deeper frontier. A company carrying none would have one exactly at net asset value — the special case that the familiar rule has quietly generalised into a law.
One consequence is immediate: a published accretion figure is meaningless without its funding assumption. On the same company at the same price, the all-equity test reads minus 89 basis points and the blended test reads minus 40. Forty-nine basis points separate the two, both are defensible, and only one can be the number in the note. Decide which test is being run before running it, write the funding mix down beside the answer, and do not change it between companies.
Placing a company on this line needs four inputs: adjusted funds from operations per share, the share price, net asset value per share and the transaction cap rate. Two divisions and one subtraction. The position is an observation and it is arithmetic. Anything said about where the shares go next is a model, and it should be labelled as one.
Divide adjusted funds from operations per share by the share price. That is what a new shareholder receives in cash earnings per dollar invested. On the worked company, $2.117 against a price of $34.50 gives 6.14 per cent, and against a 5.25 per cent acquisition cap rate external growth is dilutive by 89 basis points.
Materially. The all-equity comparison reads minus 89 basis points. Funding thirty per cent with debt at 4.5 per cent reads minus 40 — still dilutive, less than half as badly. The break-even price falls from $40.32 to $38.00, moving the frontier from a 6.2 per cent discount to an 11.6 per cent discount.
External growth stops, so the discount compounds. On the worked company accretion runs from minus 89 to minus 142 to minus 207 basis points, the discount widens from 19.7 per cent to 39.2 per cent, and the shares finish at $26.15 — down 24.2 per cent with nothing changed in the portfolio.
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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