If a client owns an office building or manufacturing facility, or any other type of real estate for that matter, it will affect the business’s value. So, the issue at hand is how? Finding out will generally require the input of both a business valuator and a real estate appraiser.
Assumptions and inputs
Business valuators and real estate appraisers use similar methods, but there are important distinctions between the two. Although both use some combination of the income, market and asset-based approaches to valuation, the assumptions and inputs on which they rely may be different.
A business valuator using the income approach, for example, might calculate the present value of the business’s expected future earnings or cash flows, while a real estate appraiser might determine a property’s fair market rental value. A business valuator using the market approach might refer to “guideline” public companies that are comparable with the subject business, while a real estate appraiser might look at sales of comparable buildings or land.
Link between values
Whether you need a business valuator, a real estate appraiser or both depends on the extent to which the business’s value is linked to the value of its underlying real estate. If a company’s revenues are derived from owning or leasing real estate, for example, a real estate appraiser is likely to be the primary valuation professional. Even so, a business valuator may be needed to determine how the form of ownership affects value.
In other cases, real estate is incidental to business value. Say a business owns real estate simply as an investment, or it owns its facilities but derives its revenues primarily from non-real-estate-related activities, such as producing goods or providing services. Here, a business valuator takes the lead role, and a real estate appraiser may or may not be necessary, depending on the business’s real estate holdings relative to its overall value.
Nevertheless, non-real-estate businesses may derive significant value from the location or characteristics of their real estate. Examples include retail stores, auto dealerships and restaurants. For these businesses, a business valuator and real estate appraiser work together to determine the best approach for incorporating real estate value into enterprise value.
Splitting value
If a business has significant real estate holdings, splitting its value into its business and real estate components can lead to a more meaningful value conclusion. This is particularly true when the real estate produces little or no income but has appreciated greatly in value. A failure to split the business and real estate components could result in an incorrect value. Valuing the business as a whole may not reflect the real estate’s contribution to value.
To value real estate separately, the appraiser determines a fair market rental value for the property. The business valuator removes the real estate (and the related income and expense items) from the books and estimates a hypothetical rental expense to the business, which reduces the earnings or cash flows on which the valuation is based. The resulting business value is combined with the stand-alone value of the real estate to arrive at a total enterprise value.
When using the guideline public company method, whether real estate should be valued separately may depend on the comparability of the guideline companies. If the subject company owns its facility but guideline companies lease theirs, it may be appropriate to treat the real estate separately.
The best solution
With business valuations, it’s necessary to consider the value of any real estate owned by the business. To ensure a solid valuation, work with a business valuator and a qualified real estate appraiser.
Your county Assessor and their appraisers use one or more of the three approaches to value to produce appraisals that are used by the Assessor to estimate fair market value for property tax purposes. The Cost Approach estimates value based on the typical cost of materials and labor necessary to build a structure of similar size and quality in that location while accounting for depreciation due to age and condition. The Sales Comparison Approach estimates value based upon the price, in the local market, necessary to acquire a property of similar location, quality, size, age, and condition. The Income Approach estimates value based upon typical market income of a similar property.
Cost Approach to Value
In the cost approach to value, the cost to acquire the land plus the cost of the improvements minus any accrued depreciation equals value. Depreciation is a loss in value from any cause, and can take the form of physical deterioration, functional obsolescence, or economic obsolescence. The underlying premise of the cost approach is that ‘a potential user of real estate won't, or shouldn't, pay more for a property than it would cost to build an equivalent.’ (PRINCIPLE OF SUBSTITUTION)
Sales Comparison Approach to Value
The sales comparison approach is directly rooted in the real estate market. The value of the subject property is equal to the sales prices of comparable properties plus or minus any adjustments. The sales comparison approach compares a piece of property to other properties with similar characteristics that have been sold recently. The sales comparison approach takes into account the affect that individual features have on the overall property value, meaning that the total value of the property is a sum of the values of all of its features.
Income Approach to Value
The income approach quantifies the present worth of future benefits associated with ownership of the real estate asset. The income approach comes in two different forms: net income approach and gross income approach. Net income is what is left over after vacancy and collection loss and allowable expenses have been subtracted from the potential gross income. The net income is divided by a capitalization rate (the investor’s desired rate of return) for an estimate of value. In the gross income approach, the income is multiplied by a factor in order to arrive at the value. The net income approach is typically seen on larger commercial occupancies like office buildings, retail, apartments and hotels / motels. The gross income approach is typically seen on income producing residential properties.