Case Study of Value Analysis on Preferred Investment Securities of Special Purpose Companies (TMK)

As an example of evaluating financial claims backed by real estate assets, we introduce a case study of value analysis on the preferred investment securities of TMK.

Introduction

In the valuation analysis of financial claims backed by real estate assets, applying the Income Approach may be useful, and determining it based on the Discounted Cash Flow (DCF) method using Free Cash Flow to Equity (FCFE). While the DCF method may also be applied in real estate appraisal valuation for physical properties, the nature of cash flows and corresponding discount rates may differ. In this article, we will introduce a case study of value analysis on the preferred investment securities of TMK.

Case Overview

The client is considering the acquisition of beneficial interest rights (trust assets: TMK's preferred investment securities) held by a subsidiary, and valuation analysis (market valuation) is required from a tax perspective.

While the specific assets of TMK were domestic real estate, the asset under analysis is the preferred investment securities in TMK. Additionally, due to the investment scheme adopted, involving multiple domestic and foreign vehicles, and considerations such as the analysis of Waterfall during the business planning period, a valuation analysis was required.

Overview of Value Analysis Approach

The general methods of value analysis approach are as follows. While considering multiple methods or selecting and applying the most compelling method, it is important to consult with the client according to the specific case and proceed accordingly.

In this matter, considering the analysis of the dividend Waterfall, it was deemed necessary to assess value. Therefore, the Income Approach, which analyzes value based on expected profits or cash flows from the target, particularly the Discounted Cash Flow (DCF) method, which calculates value by discounting the future cash flows of the target company to present value, was considered useful.

Analysis using the DCF method (Cash flows and discount rates)

Cash flows

Given that this is an evaluation of preferred investment securities, we based the calculation of Free Cash Flow for Equity (FCFE) of the subject financial claims on TMK's net profit for the period. This net profit was derived from a combination of profit and loss similar to real estate valuation, considering operating expenses of vehicles such as AM fees, interest payments, taxes, etc., based on the business plan. We also considered expenses such as corporate taxes at the vehicle level and Waterfall between multiple vehicles when calculating FCFE.

Discount rates

Taking into account the nature of the specific assets, we considered it useful to determine the cost of equity capital based on the Capital Asset Pricing Model (CAPM), using financial data, beta, and market data of listed Real Estate Investment Trusts (REITs) in Japan. Since REITs listed in Japan have different characteristics as portfolios depending on the asset class, we selected stocks with high similarity to the specific assets.

Given the observed impact of COVID-19 on the J-REIT market, we needed to consider the nature of TMK's specific assets when determining the most suitable period for the weekly or monthly observation period used for beta calculation. Additionally, when adopting beta, we needed to consider factors such as excluding those with a coefficient of determination (R-squared) of less than 0.1 or a sample size of less than 100.

Analysis using the DCF method (Analysis Period and Terminal Value, etc.)

Analysis Period and Terminal Value

The analysis period was set based on the number of years commonly adopted in the world of real estate valuation (10 years), among other considerations. Regarding the terminal value, two scenarios were considered: adopting a going concern value based on distributions and assuming liquidation through the sale of real estate. Considering the nature of the specific assets, the liquidation value was adopted.

Other Considerations

In conducting this evaluation, the analysis was based on the business plan provided by the client. However, various conditions such as loan repayment (repaying the entire excess amount beyond the required cash on hand), required cash on hand (considered as a certain percentage of operating expenses each period), and distributions from TMK (distributions are made only if TMK's net profit for the period is positive) were assumed based on standard investment practices, after careful consideration and detailed setting.

Conclusion

In the valuation analysis of preferred investment securities, the Income Approach, as in this case, may be useful. However, conducting such analysis requires expertise in real estate, accounting, taxation, etc. Additionally, when international elements are involved in the scheme, expertise in the respective countries is necessary.

Moreover, in establishing valuation assessment policies and logic, relying solely on knowledge related to real estate or stock valuation may make it difficult to conduct convincing analysis. In cases like this, where a comprehensive perspective is required for analysis, it is crucial to consult consultants who can provide support from various specialized areas.

The Deloitte Tohmatsu Group provides comprehensive support from a neutral standpoint, including various valuations, analysis of real estate investment schemes, and legal, accounting, and taxation aspects, to ensure thorough and consistent assistance.