How do funds value properties? Methods, valuers and NAV

Funds value their properties by asking qualified valuers, usually independent of the manager's investment team, to estimate what each building would fetch in an orderly sale between willing parties. The valuer typically uses the income approach, which converts expected rent into a value, and cross-checks it with the comparison approach, based on similar transactions, or the cost approach, based on what it would cost to replace the building. The result is an informed estimate, not a price anyone has paid. Valuations are updated at intervals set by the fund rules, so the fund's net asset value (NAV) moves in steps and can lag what is happening in the market. Understanding this helps you read the NAV with the right degree of caution.

Why does a property fund need valuations at all?

Shares in a listed company have a price every trading day. A building does not. It changes hands rarely, each sale is negotiated, and no two buildings are identical. Yet a fund must state what its portfolio is worth so that it can calculate the NAV per unit, charge fees that are based on assets, report to investors and, where redemptions or new subscriptions are allowed, deal at a fair price.

Valuation fills that gap. It is the process of turning a set of buildings, leases and assumptions into a number. Because that number drives the NAV, it affects what new investors pay, what exiting investors receive and how performance is reported. See valuation and NAV for short definitions.

Who is the independent valuer?

Managers of alternative investment funds, including ELTIFs, operate under the organisational rules of Directive 2011/61/EU (AIFMD). Those rules cover the manager's organisation and administration, including the prevention of conflicts of interest, and the fund documents describe how valuation is organised. In practice, many real-estate funds appoint an external valuer, a firm or individual with professional qualifications, to value the properties. Where valuation is performed internally, check how the documents describe its separation from portfolio management.

Independence matters because the manager usually earns fees linked to the value of assets under management. A higher valuation can mean higher fees and better-looking performance. An external, qualified valuer with a clear mandate reduces, though does not remove, that conflict. The fund documents should name who values the assets, how the valuer is appointed and replaced, and how often the valuer is rotated, if at all.

What methods do valuers use?

Valuers rarely rely on a single method. They choose the approach that suits the type of property and the information available, and they often cross-check one method against another.

How does the income approach work?

For an income-producing building, the valuer looks at the leases: the rent, when each lease ends, whether rent is indexed, and the quality of the tenant. The valuer then estimates what rent the space could achieve in the market, how long vacant space might take to let, and what costs the owner cannot pass on to tenants. These cash flows are converted into a value using a rate that reflects the risk and the market. A small change in that rate can move the value noticeably, which is why it is one of the most important assumptions in any report.

When is the comparison approach used?

The comparison approach works well when similar buildings in a similar location have recently been sold. The valuer adjusts each comparable sale for differences in size, condition, lease terms and timing. When few transactions take place, for example in a slow market, the evidence becomes thin and the valuer must rely more on judgement.

What about the cost approach?

The cost approach asks what it would cost to buy the land and put up an equivalent building today, then deducts an allowance for wear and outdated features. It is used mainly for unusual properties where neither rental evidence nor sales evidence is reliable.

Why is a valuation only an estimate?

Every valuation rests on assumptions about the future: rents, vacancy, interest rates and what buyers will be willing to pay. Two competent valuers can reach different figures for the same building. A valuation is also a snapshot at a specific date. If the market moves afterwards, the figure in the report does not.

The real test of a valuation is a sale. A fund that sells a building below its last valuation has to absorb the difference, and the NAV falls. That is why investors should look at how sale prices compare with previous valuations when the fund reports disposals.

How often are properties revalued?

The frequency is set by the fund rules and the prospectus, within the framework of the applicable regulation. Some funds revalue each property at regular intervals and update the NAV accordingly. Others combine a full valuation at longer intervals with lighter desktop reviews in between. Check the documents for both the valuation frequency and the NAV calculation frequency, because they are not always the same.

Why does the NAV not change daily, and why can it lag the market?

Because buildings are revalued at intervals and valuers rely on past transactions, a property fund's NAV tends to move smoothly and with a delay. If market conditions change quickly, for example after a rise in interest rates, it may take several valuation rounds before the NAV fully reflects the change.

This smoothing has consequences:

• It can make the fund look less volatile than it is. Smooth NAV movements do not mean low underlying risk.
• It can create unfairness between investors. If redemptions are allowed and the NAV is above what the buildings would fetch today, those who leave are paid too much at the expense of those who stay, and the reverse is true in a rising market.
• It affects reported performance. A fund may report stable returns until a revaluation catches up, then report a sharp move.

For an ELTIF, the link to redemptions is narrower, because by default investors cannot redeem before the end of the fund's life, and redemptions during the life are possible only under the conditions of Article 18(2) of Regulation (EU) 2015/760. Valuation still matters for the price of any transfer of units, for fees and for the value you receive at the end. See ELTIF liquidity for the redemption rules.

A practical example

A hypothetical illustration, not data on any fund: a fund owns an office building whose main tenant has a lease ending soon. The last valuation assumed the tenant would renew. Shortly after the valuation date, the tenant announces it will leave. Until the next valuation, the NAV still reflects the old assumption. At the next valuation, the valuer adds an allowance for a period of vacancy, letting costs and possibly a lower rent, and the value of the building falls. An investor who looked only at the earlier NAV would have seen no sign of the change.

What should I look for in valuation reports?

Annual and semi-annual reports usually summarise how the portfolio is valued. Useful points to check:

• Who values the properties, and whether the valuer is external and independent.
• Which methods are used for which property types.
• The key assumptions, especially rental levels, vacancy and the rate used to capitalise or discount income.
• How sensitive the values are to changes in those assumptions, if the report shows it.
• How sale prices of disposed properties compared with their last valuations.
• Any material uncertainty clauses, in which the valuer warns that the market evidence is limited.
• How the fund values properties under development.

The guide to ELTIF documents explains where these items usually appear, and the real-estate fund risks article puts valuation risk in context with the other risks.

What are the risks and limitations?

Valuation risk is the risk that the reported value of the portfolio differs from what the assets would fetch in a sale. It rises when markets are moving fast, when few transactions take place, when buildings are specialised, and when the fund uses leverage, because borrowing amplifies the effect of any change in value on the NAV. Under Article 16 of Regulation (EU) 2015/760 as amended, an ELTIF that may be marketed to retail investors can borrow up to 50 % of its NAV, so the interaction between valuation and leverage is worth understanding.

No valuation method removes uncertainty. Independent valuers, clear procedures and transparent reporting reduce the risk of error and conflict, but they cannot predict the price a buyer will pay tomorrow.

Frequently asked questions

General information. Not investment advice or a suitability assessment.

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