Business Valuation

Business valuation is performed using a process similar to that of real estate appraisals – though the data sources are different.

Reasons for business valuation engagements include:

  • Estate tax valuation and planning
  • Business purchase price allocation
  • Divorce
  • Loan documentation
  • Litigation
  • Research to determine the asking price for a business
  • Documentation to determine that a purchase price is equitable.

Business Valuation Options

Multiple of revenue

The revenue multiplier varies from industry to industry and according to the size of the business. The appraiser compiles data for similar types of businesses with similar levels of sales and determines the business valuation based upon industry rules of thumb, features for the subject property and comparable sales and data for the sales.

Comparable sales

The appraiser seeks information for similar businesses which sold recently including revenues, net profits, assets, liabilities.

Cash flow/income approach/earnings based methods

Options include a discounted cash flow analysis and multiplier of net income (typically net income before interest, taxes, depreciation and amortization, sometimes referred to as EBITDA).

Asset based valuation

This business valuation method is a hybrid of the net value of assets plus a multiplier of annual cash flow. The multiplier is typically relatively low since it is added to asset value.

Methods for business valuation vary with the type of business. Mid-market to large businesses are more likely to sell based upon a multiplier of EBITDA. Smaller businesses are more likely to sell based upon a multiplier of revenue or an asset based valuation methodology. The success and outlook for the business also affects the business valuation method and multiplier. A business with poor recent financial results and uncertain future prospects is more likely to sell based upon assets than on a multiple of revenue or EBITDA. A successful mid-market business with steadily growing revenues and net profits would be more likely to sell for a multiple of EBITDA.

Feasibility Studies

A feasibility study is a combination of a market study and financial analysis used to determine if it is financially feasible to develop a proposed property. They are also performed to evaluate the feasibility of renovating or upgrading an existing property. These studies determine whether a property is financially feasible and whether its complete and stabilized value are equal to or exceed

  1. Total cost to build it
  2. Entrepreneurial profit
  3. Adequate return for the capital invested to develop.

Steps of a Feasibility Study

Development of scope of work with client

Gather data (rent comparables, properties under construction, proposed properties, market occupancy and absorption, submarket occupancy and absorption and data for economic drivers which impact future prosperity for the real estate market); and

Analysis of data to develop opinions of market

rent, stabilized occupancy and the time likely required for the proposed property to reach stabilized occupancy.

Most market studies focus upon the revenue portion of a profit and loss statement. They do not address operating expenses or the value of the property at stabilized occupancy. A feasibility study addresses the factors in a market study and also addresses operating expenses and the value as stabilized. Feasibility studies also address whether the indicated market value is sufficient for the property to be financially feasible.

A feasibility study involves two areas where seasoned judgment is necessary:

  1. Market rent, occupancy and absorption
  2. Determination of the amount of entrepreneurial profit and return for the equity investor necessary to make a property financially feasible.

Highest and Best Use Analysis

Highest and best use analysis can assist an owner in maximizing return. Highest and best use analysis can be performed for acreage, site development, and improved properties. Research and planning can substantially increase investment returns.

In a metropolitan area, highest and best use can be a combination of uses including single-family, multifamily, and commercial. Mixture of uses and timing of development are both critical factors. Commercial and multifamily land will yield a higher value, but artificially calling a use commercial will result in an excessive holding period. Ultimately the highest and best use may be single-family.

Highest and best use for a single site may seem intuitive. For example:

  • It is clearly an industrial site since it is in an industrial park or
  • It is clearly a strip center site since it is on a major thoroughfare at the corner of a street which enters a subdivision. However, an appropriate highest and best use study will be detailed and precise.

Consider the following issues:

  • Tilt wall versus metallic
  • Office warehouse versus warehouse versus flex
  • Percentage of office build out
  • Quality of office finish
  • Depth of truck apron
  • Eave height
  • Truck wells versus grade level versus dock height
  • Sprinkled
  • Parking ratio
  • Level of landscaping
  • Quality of finish for front of building
  • Type of elevation for front of building
  • Cranes
  • Stabilized yard

For an existing building on two acres, the following should be addressed:

  • Is the current use the highest and best use or should improvements be demolished? (Explain if used as improved, land and demolition, highest and best use is demolition).
  • Should existing use be revised or upgraded

Consider the following examples:

  • Old office building in central business district into lofts
  • Old big box into self-storage
  • Apartments to condominiums
  • Upgrade class C apartments in affluent area to class A-/B+
  • Convert warehouse to flex
  • Cure deferred maintenance and renovate class C office building into class B office building

Research and analysis by seasoned real estate professionals can help identify highest and best use to maximize returns.

 

Market Rent Analysis

Market rent analyses evaluate the subject property, competing properties, and market conditions to document an equitable level of rent in an arm’s length transaction. Estimates of market rent are developed regularly for market studies, appraisals, lease disputes, and to provide an owner or prospective investor with objective opinions.

Steps in market rent analysis include:

  • Review of subject property
  • Visit to subject property and interview of on-site staff
  • Selection of rental comparables
  • Data on rental comparables
  • Visit rent comparables and interview on-site staff
  • Review of market data regarding rental and occupancy rate trends
  • Summarization of rental rate features and amenities of subject property and amenities
  • Adjustments for differences between sale price and comparables (based upon data and insights obtained during visits to rent comparables)
  • Summarization of and report conclusions (report can be oral to detailed narrative report).

When contemplating a market rent analysis it is prudent to consider including suggestions for financially feasible upgrades as part of the scope of work. The data gathering and analysis will take a modest about of additional time. Suggestions for upgrades can enable the owner to substantially enhance the value of the property.

Real Estate Consulting

Real estate consulting covers a breadth of areas including market rent study, market study, feasibility study, highest and best use analysis, cost segregation and analysis for an underperforming asset. Clarifying the client’s objectives and expectations is the cornerstone of a successful real estate consulting engagement.

Real estate consulting begins with a detailed discussion regarding the concerns, constraints and time frame related to an assignment. The scope of work and reporting requirements can be developed through a series of interactive questions regarding relevant topics.

Real estate consulting could include:

  • Highest and best use for 5,000 acres in a metropolitan area
  • Highest and best use for 3 acres on a major thoroughfare in a metropolitan area
  • Highest and best use for 40 year old office building in an area of re-gentrification
  • Market rent study on a floor-by-floor basis for 50 story office building
  • Market rent study on a floor-plan by floor-plan basis for 256-unit apartment complex
  • Evaluation of efficacy of leasing effort for industrial building
  • Evaluation of management for an office building
  • Review of level of operating expenses for an apartment complex
  • Evaluation of whether proposed scope of work to renovate an upgrade an apartment complex is appropriate
  • Development of the scope of work to renovate and upgrade an office building
  • Confirmation of whether a retail strip center is the highest and best use of a site
  • Review of real estate portfolio and suggestion of changes based on market conditions, market trends, and the investor’s objective
  • Preparation of an evaluation of market status and likely trends for an individual asset to provide guidance regarding whether or not to sell
  • Due diligence regarding a pending acquisition
  • Due diligence for a contemplated disposition.

Clearly defining the client’s objectives helps generate an appropriate scope of work.