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How it’s always been
Business valuation has always relied on the triangulation between three different methodologies: discounted cashflow (DCF), comparable analysis, and some form of dividend valuation approach. None of them are generally sympathetic to book values which may vary substantially from market reality. The first treats the company’s operations as a stream of future cashflows, to which should be assigned a cost of capital. Great in theory, but it has always been subject to manipulation by vested interests, especially over-optimistic sales forecasts, both for price and volume, but also lower-than-reasonable projected costs. This has been especially prevalent for developers: the valuation of Emaar Properties before the financial crisis implied a truly extraordinary rate of growth and delivery of units over the period until around now. DCF valuation is also very dependent on the terminal value, the point at which forecasts are translated into some final number representing the value of the company at a distant point in the future. Companies are lasting shorter periods than they used to: there is a big risk in assuming significant terminal values, except for land. The second method, comparables, rightly assumes that the value of anything, including a construction company, is what someone – in this case, investors collectively – are prepared to pay for it. The metric usually used is Price/Sales, Price/Earnings or both, the choice depending, at least in part, on whether the sector has relatively consistent levels of leverage. Comparables work well when there is a lively, liquid, relatively homogenous marketplace, such as for apartments in a major city like Dubai. They work much less well when available comparables are few and far between, and very heterogenous. They don’t work at all when a company is completely unique, although thankfully, very few are. Real estate development companies have been valued using both methods. Lastly, a dividend valuation methodology works on the principle that a company resembles a bond to a large extent, so its dividends, with their rate of growth, can be regarded as a reflection of its future total earnings. One final note – academics look away now – in many cases, businesses, even large ones, are valued in practice on the basis of a ‘rule of thumb’, known to industry participants, which can be any metric: a multiple of turnover or EBITDA, the quantity of a particular asset, or something more esoteric, especially when a company is not yet profitable, such as rate of growth of sales, number of clicks or even Facebook likes. Note: as of now, there isn’t such a rule for real estate developers.
Rise of the Robots – transformers for real estate?
Construction costings have been a relatively comprehensible, if not always stable, aspect of real estate construction company valuation. Regular costings reports, from quantity surveyors, and engineering firms such as Aecom, have enabled stockbrokers, except on a few occasions such as during rapid cost rises in the Gulf last decade, to place their emphasis on future sales prices rather than inventory management or contracts when they assess value creation by developers. Advisers such as BCG and KPMG as well as companies in the front line such as Roland Berger now believe that this relatively cosy valuation environment is about to experience disruption and permanent change. They argue that the introduction of robotics, 3D printing and drones into construction has already started to diminish costs, perhaps by up to 20% eventually by comparison to a 2018 benchmark, and reduce construction timescales. If prices were to be maintained, this would represent a windfall gain to be divided between developers and construction companies, depending on their relative bargaining power.
But will they be? At present, in the UAE as elsewhere, stockbrokers and investors in developers are placing their stress on current dividend payments, with valuations running under book values, and taking an interest in short-term considerations such as sales backlogs, quarterly revenue figures, and even passive investor activity depending on inclusion in MSCI indices. To compound the indifference to change, in any relatively flat market, DCF runs below valuation through comparables. As yet, there is no evidence that investors are discriminating amongst developers, whether in the UAE or anywhere else, based on their adoption of new construction technology.
The reason could well be this: investors and stockbrokers alike believe that as the new technology will rest primarily with construction companies, access to it will be potentially universal across developers, no one will miss out, and uptake will be gradual and dispersed. Construction costs will fall generally, the beneficiaries will be end-users on the one hand, and early-users, usually large, construction companies at the other end, with developers neither gaining nor losing value. Even the construction companies will eventually be squeezed.
This generally indifferent attitude of investors to date towards the technological component of developer portfolios and that used by their construction companies may turn out to be a mistake. Firms such as Winsun, which built the Office of the Future, a 3D printed office in Dubai, are participating in a market for concrete printing which Visiongain estimated already to be worth USD 27.8 million in 2019, whilst major 3D printing companies like Carbon are running multiple VC investment rounds at stratospheric valuations. This is quite aside from market disruptors such as OpenDoor and Compass, which have also gained valuations well ahead of traditional developers. All this surely suggests the emergence of a segmented market in which economies of scale in production will finally reach the real estate market, especially for residential property, and the industry will finally outgrow its reputation for slow adoption of innovation and dependence on financial structure (e.g. off-plan sales) for profitability.
On the demand side, real estate prices are driven by wealth and income. Better construction technology does not threaten them. So, in the long term it is not likely that real estate prices will fall to reflect technical advances, because the other component, land prices, will rise to compensate. Developers with larger, better land banks will make yet further strides ahead of their competitors. DCF valuation of developers will rest even more than they do at present on their land banking strategy, which developers will have to present much more transparently and explicitly than they are now, or else risk losing value through opacity. That side of the equation will not change its internal logic.
But in the short-to-medium term, the early and successful adoption of new, cheaper construction techniques by real estate developers will obviously improve profit margins, especially by comparison to more tardy adopters. To the extent that there is pressure on prices, the really interesting possibility is that as technology seizes hold of the real estate development industry, the traditional metrics by which developers have been valued will, at least temporarily, be set aside. Future market share will be determined by technology adoption, as it was, or thought to be, when the commercialisation of the internet began. In general, terminal values, apart from land, will be shorter in timeframe and possibly lower. As Miller et al (2018) argued, ‘Value in the industry will become even more concentrated in the hands of those who hold the IP and who innovate’. As yet, however, investors are not even aware of which developers are well placed, and which not.
Note to the consultants: new developer valuation metrics?
It is striking that for the time being, KPMG’s Innovations Overview resembles a list of what is happening, a collection of companies. In the future, such an Overview will likely deliver a lot more structure, and become of great value to investors as times change for developers.
Just as when the Internet began, the scale and effectiveness of web presence became a valuation metric in its own right, so the opportunity therefore now exists for investors to work in conjunction with construction consultants and management consultants to develop methods of assessment – such as the percentage of their revenue reinvested in R&D, which has been traditionally low in construction. They may even develop indexes of technology adoption for construction companies. We may even yet find rules of thumb to value developers.
 Appraisal Economics (2018) Commercial Real Estate Development Company. 22 January 2018. Available at: https://www.appraisaleconomics.com/commercial-real-estate-development-company/ Retrieved 18 August 2019.
 Hyde, S. (2018) Rules of Thumb and Business Valuation. 3 December 2018. Available at: https://americassbdc.org/rules-of-thumb-and-business-valuation/#targetText=According%20to%20that%20rule%20of,swing%20in%20value%20of%20%24200%2C000. Retrieved 18 August 2019.
 Reliant Business Valuation (2019) Risky Business: Relying on Valuation Rules of Thumb. Available at: http://www.reliantvalue.com/valuation-rules-of-thumb/ Retrieved 18 August 2019.
 Aecom (2018) Property and Construction Handbook ‘18’19 Available at: https://www.aecom.com/ae/wp-content/uploads/2018/10/Construction-Handbook-2018_19.pdf Retrieved 18 August 2019
 Miller, S. Dyer, A., Raby, M, Castagnino, S. and Hill, J. (2018) Getting Ready for Robotics in Property Development and Building Boston Consulting Group 25 October 2018. Available at: https://www.bcg.com/publications/2018/robotics-property-development-building.aspx Retrieved 18 August 2019
 KPMG (2019) Real Estate Innovations Overview (4th edition), June 2019. Available at: https://assets.kpmg/content/dam/kpmg/nl/pdf/2019/advisory/kpmg-real-estate-advisory-4th-edition-june-2019.pdf Retrieved 18 August 2019
 Xinhua (2018) Interview: AI, robotics to reduce construction costs in Gulf region by 20 pct: expert. Xinhua 29 September 2018. Available at: http://www.xinhuanet.com/english/2018-09/26/c_137492454.htm Retrieved 18 August 2019
 Visiongain (2019) 3D Concrete Printing Market Report 2019-2029. [pay wall] https://www.visiongain.com/report/global-3d-concrete-printing-market-2019-2029/ Retrieved 18 August 2019
 Sawyers, P. (2019) 3D printing platform Carbon raises $260 million at $2.4 billion valuation. VentureBeat.com 25 June 2019. Available at: https://venturebeat.com/2019/06/25/3d-printing-platform-carbon-raises-260-million-at-2-4-billion-valuation/ Retrieved 18 August 2019
 Delprete, M. (2019) Inside Compass – Part 3 Valuation. May 15 2019. Available at: https://www.mikedp.com/articles/2019/5/15/inside-compass-part-3-valuation Retrieved 18 August 2019
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