In 2022, Danish pension funds recognised much lower impairment losses for property assets than for listed investments. However, this does not necessarily mean that the book value of the property assets is too high.
On the heels of 2022, when prices of stocks and bonds dropped across the board, focus is on the valuation of unlisted assets, including property assets. Most recently, in the final days of 2022, the Danish FSA stated that “[t]he FSA finds it remarkable, however, that significant discrepancies are observed between the value adjustments of pension funds’ alternative investments and the value fluctuations observed in the listed markets. It is important for the individual pension saver that pension funds carry out a true and fair valuation of their assets”. At the same time, several market observers have been puzzled by the claim that property prices have dropped less than the share prices of listed property companies. What is fact, what is fiction?
In 2022, Danish pension funds recognised much lower impairment losses for property assets than for listed investments. However, this does not necessarily mean that the book value of the property assets is too high. Among pension funds that do not avail themselves of external valuation skills, there has in some years of rallying market prices been a tendency to take a conservative approach to valuations, with such hidden reserves being brought to the fore in a year when the returns on other asset classes have been poor.
Should institutional investors happen to net sizable profits relative to book values when divesting property assets or other unlisted assets, it is often evidence of extraordinary caution having been taken in the valuation. In other words: In good times, investors will tend to be slightly less aggressive than the market in their valuations, which means that in bad times, there is no need for any substantial downward adjustment – a manoeuvre referred to as “smoothening the curve”
Direct comparison between property prices and the price of listed property shares is nonsensical
Several analysts have claimed that the drop (often by some 50%) in the prices of listed property shares in 2022 should trigger a similar sharp drop in the valuation of institutional property portfolios.
It would be reasonable to assume that the market value of a listed property company should correspond to the market value of the company’s property portfolio after debt. However, such an assumption is based on a fallacy.
As shown in Figure 1, in early 2022, listed property companies in the Nordics traded at prices that nearly corresponded to twice their book values. This hardly signified that the book values recognised by the companies were too low, but rather that stock market investors were overly optimistic in their assessment of potential capital growth, much more optimistic than property market investors. Or perhaps, which seems even more likely, it was a manifestation of the stock market’s sometimes irrational optimism, in 1996 coined “irrational exuberance” by former chair of the Fed, Allan Greenspan, i.e. a phenomenon driven by market psychology as opposed to market fundamentals.
Today, property companies typically trade at book value or below – without this necessarily having any bearing on the fundamental assessment of the real value of underlying market values, but rather or just as well signifying exaggerated market pessimism.
In other words: Of course, the long-term capital growth of listed property companies is directly correlated with developments in the property market. However, in the short term it often turns out that the stock market is driven by market psychology to such an extent that the price movements of listed property companies by no means reflect movements in the property market. And the fact that the prices of listed property companies have dropped by some 50% in many cases signifies that the exaggerated optimism in the stock market as of end-2021 has now disappeared, rather than signifying a sharp drop in underlying property values.
