Beta and unlevered beta are common financial tools for comparing companies before investing in their stocks. But did you know you can use unlevered beta when investing in real estate, too?
When you receive a prospectus from an investment firm, you want to do your due diligence on the investment and the firm itself. While beta helps you assess financial risk associated with the combined equity and debt of the investment, unlevered beta helps you assess the risk using only the investments’ assets. Best of all, it’s easy to calculate. Let’s dive in.
What Is Unlevered Beta?
Unlevered beta, also known as asset beta and unlevered beta, calculates the market risk of a company disregarding debt — focusing only on company assets. It’s the asset beta of a company without the debt. It ignores the financial burden of leverage, hence the name unlevered beta.
Just like beta, also known as levered beta and equity beta, unlevered beta compares a stock’s risk against the market. However, unlevered beta ignores all effects (positive or negative) brought by debt. This helps an investor figure out where the risk of the stock lies.
Unlevered beta is normally lower than levered beta. This may not be true in the case that a company’s net debt is negative.
How to Calculate Unlevered Beta / Asset Beta
Here’s how to find asset beta. To find the unlevered or asset beta of a company, we need to look up the beta, un-lever it, find the median set, and then re-lever it based on the comparable company’s capital structure.
The formula for unlevered beta is as follows:
The formula for re-levered beta is:
Levered Beta = Unlevered beta x (1+((1 – tax rate) x (Total Debt/Equity)))
Unlevered beta removes the chance of accidentally identifying a stock as risky due to a high debt-to-equity ratio. Debt can also cause a stock’s price to be more sensitive to the market. These factors are all external to the company’s actual market risk, and unlevered beta removes these factors.
It is mostly useful when comparing companies with contrasting capital structures because it focuses on equity risk.
An Example of Unlevered Beta in Real Estate
Below are the beta figures for Real Estate Investors PLC:
On the table above, you can see the beta is lower than one. This means that the volatility of this stock is lower than the market volatility, also called systematic risk. When a company has a beta of one, it means it has the same systematic risk as the market.
You can also observe how the unlevered beta is lower than the levered beta.
Compare this with a comparable company such as The Black Stone Group:
Now you can see the different capital structures the two companies hold. The figures above suggest Real Estate Investors PLC have higher debt which skews their levered beta data.
If you were to compare the levered beta, you would deduce that the two companies’ market risk are not too dissimilar — granted Real Estate Investors PLC is less volatile. However, when comparing their unlevered beta, you will see there is a vast difference in their equity risk.
How Does Unlevered Beta Help Real Estate Investors?
Unlevered beta gives an investor clarity on the composition of risk when buying a stock or making another type of investment. In real estate, investors can use unlevered beta to compare two assets against each other without considering how their debt is affecting them.
You might find yourself using unlevered beta when comparing two offering memorandums, investing in REITs or diversifying your real estate portfolio. However, because risk is essentially built into real estate investing, you may find it difficult to reach a zero beta portfolio. Always be sure to consider debt-to-equity ratio in addition to unlevered beta when it comes to real estate investing.
Determine Your Desired Level of Risk
When comparing investments, it’s a great idea to look at your options from multiple perspectives before putting your money in. Keeping your portfolio diversified with risky and safe investments will help you maintain your wealth. Beta, unlevered beta, the break-even ratio and debt ratio are help accounting equations that could save you thousands.