Valuing a real-estate company holding a leased property: simple net-asset method

This note briefly outlines the main theoretical features of the simple net-asset method and examines its practical application through the case of the real-estate company “Alfa”, focusing in particular on the approach applied to re-express the leased property at current market values — a central and distinctive element of the valuation.

The simple net-asset method is based on determining adjusted net assets, which represent the economic value of the company’s asset base as of the valuation date. The starting point is the company balance sheet, where all assets and liabilities are recorded.

The firm value therefore equals the adjusted net assets, obtained by re-expressing each balance sheet item at current market values.

The formula of the simple net-asset method may therefore be expressed as follows: 

𝑊 = K

In order to arrive at this result, a detailed analysis of every single balance sheet item needs to be conducted to ascertain whether the accounting (book) value needs to be updated so as to ensure that the balance sheet correctly reflects the company’s economic capital. In addition to the balance sheet, supporting documentation such as the inventory ledger and fixed-asset records is useful for the purposes of precisely determining the accounting values of individual items.

The criteria for estimating current market values depend on the nature of the item. Property, plant and equipment should be valued by distinguishing between assets for which an active market exists and assets for which the cost of replacement or reproduction must be estimated. Intangible assets are relevant only if they are separately transferable. Receivables require assessment of debtor default risk, discounting of non-interest-bearing receivables where appropriate and adjustment of contractual rates if they materially differ from market rates. The same applies to payables.

Lastly, deferred tax effects — i.e., the potential tax impact arising from differences between the current values of balance sheet items and their tax-recognised carrying amounts — must be considered in order to produce a truthful and reliable representation of adjusted net assets. Deferred tax (liabilities and assets) therefore concerns the tax treatment of gains and losses that would arise on re-expression of assets and liabilities when these are realised or transferred. 

The process may be summarised as:

Alfa operates in the real-estate sector. Consistent with doctrinal guidance, the simple net-asset method was considered the most appropriate approach for determining Alfa’s economic capital.

All balance sheet items — assets and liabilities alike — were critically examined for re-expression at current values.

The main asset items, with the exception of the leased property (analysed in detail below), required no material adjustments. Tangible assets that were fully depreciated and lacked an effective second-hand market, receivables judged fully collectible and cash were retained at their nominal book values.

Deposits classified among financial fixed assets were considered fully recoverable and therefore kept at their original carrying amounts.

On the liability side, the main recorded item was a shareholder loan, which was left at its nominal book value.

Particular importance was attached to the property, an office unit, held under lease by Alfa.

Since Alfa expressed — with reasonable certainty — its intention to exercise the purchase option at lease expiry, economically the lease functioned as a medium- to long-term financing arrangement that the company used to acquire fixed assets.

Consequently, the lease was recognised following the finance-lease (substance-over-form) approach, which treats the transaction as a financing contract.

The property was recorded under assets and depreciated over its useful life, while the residual finance obligation equal to the outstanding principal portion embedded in future lease payments was recorded under liabilities.

For valuation under the simple net-asset method, we considered the difference between the current market value of the leased property underlying the contract and the amount of the residual lease liability. The market value of the property was determined using the price quotations available in the Real Estate Market Observatory of the Italian Revenue Agency (Osservatorio del Mercato Immobiliare), specifically for properties classified as structured office units. The residual lease debt was measured as the remaining lease payments plus the contractual purchase option (buyout) price.

On the basis of the above re-expression at current values, Alfa’s adjusted net assets were determined.

The only material adjustment for the purposes of this valuation was the revaluation of the leased property, which therefore generated an implicit revaluation surplus in the net-asset assessment.

This surplus was reduced to reflect potential deferred tax burdens that could arise should the business complex be transferred.

The simple net-asset method proved appropriate for valuing the real-estate company holding the leased property. The property was revalued to market levels in line with the substance-over-form principle, since the company is reasonably expected to purchase the asset at lease maturity. Generally speaking, valuations of this kind require more than a mechanical summation of balance sheet items. To re-express items at current values their true contribution to the enterprise as a whole, the strategic decisions of management and all factors that may materially affect their value need to be considered.​​​